Michael Covel is the author of the internationally bestselling book Trend Following

Plunge Protection Team

June 30, 2006

George Stephanopoulos outlines the Plunge Protection Team:

"I don't know if you remember, but in 1998, there was a crisis called the Long Term Capital crisis. It was a major currency trader and there was a global currency crisis. And they, at the guidance of the Fed, all of the banks got together when that started to collapse and propped up the currency markets. And they have plans in place to consider that if the stock markets start to fall."

Read full article (PDF). To all free market players this is unfortunate news.

We Have Met the Enemy...and He Is Us

June 29, 2006

In the quest to find interesting information, take a read of Lawrence Speidell's The Human Element...in Individual and Institutional Investing (PDF).

Pension Scam

Make as much money as possible and don't depend on some pension plan for your security. Why the bluntness? Consider this excerpt of incompetence from the June 27, 2006 WSJ:

"Delta Airlines announced last week that it will terminate its pilot pension plan, becoming the latest airline company to flip liabilities to the federal Pension Benefit Guaranty Corporation (PBGC). Congratulations, taxpayers. You'd think this might upset Congress, or at least inspire some reforms. But no such luck. In fact, House and Senate conferees are busy negotiating another pension fix that would give airlines one more reprieve and make taxpayers even more vulnerable to airline mismanagement down the road. Since 2002, far too many airline, steel, auto and other companies have dumped their pension plans on the PBGC, the quasi-government agency that "insures" private pension plans. That body has gone from a $10 billion surplus in 2000 to more than a $23 billion deficit last year, and it is the financier of last resort for a private defined-benefit pension system that is underfunded to the tune of $450 billion. On present trends, this could become a fiasco on the order of the savings and loan collapse. This is what happens when Congress socializes what ought to be private labor contracts. The theory behind the PBGC was that it would collect enough premiums from companies to cover future liabilities. But as always in Washington, unions and powerful industries have worked the political system to prevent premiums from reflecting real market and business risks. The result is today's underfunding and a looming taxpayer bailout. Congress has known about this for a long time. But it made everything worse with a previous election-year "reform" in 2004 that gave special breaks to the most underfunded companies rather than requiring that they put their pensions on a sound footing."

Who is incompetent here? The airlines, the government and the employees. Everyone is guilty of trusting someone or something. That is a bad prescription today and into the future.

Making the Case in Hard Times

June 27, 2006

Chidem Kurdas forwarded me her article today about a presentation I gave a few weeks back at Superfund's offices. As you read the article below keep in mind a quibble I have: it's not a matter of this month or the next month being a so-called trend follower's market - doesn't work that way. The ups and downs are part of the game. If you go around saying "now" is "not" the time for trend following, next month could be a huge trend following month. You can't predict performance or the unexpected events that drive that performance. Here is the article:

By Chidem Kurdas, New York Bureau Chief
Tuesday, June 27, 2006 11:15:37 AM ET

The 22-year-old futures program, the world's largest, carries higher risk than the funds of funds, according to Man Group. It is routinely subject to quick, double-digit drops. But it also yields significantly higher returns over time.

Lucky or Not?

June 26, 2006

From the Wall Street Jounral comes Russell Adams' article Is that team good -- or just lucky? An excerpt to consider:

Melky Cabrera, a highly touted 21-year-old outfielder for the New York Yankees, started off the season well, batting over .300 through early June. Now he is in a slump, hitting .189 in his last 10 games. For fans and the Yankees, the question is simple: How much of the rookie's impressive start was dumb luck? A lot of it, according to some baseball number-crunchers. Using new statistical methods, they calculated that the equivalent of one in four of Mr. Cabrera's early-season hits resulted from chance, not skill. Subtracting out good luck, his early season batting average should have been .231 -- nearly 80 points lower than what showed up in the box scores. Even in the numbers-obsessed world of sports, baseball has stood out for its efforts to track all aspects of the game. Now its fanatic record-keepers are on a quest to quantify something seemingly beyond measurement: the ethereal quality of luck. They're using insights into randomness that are shaking up other fields, from cancer research to weapons testing -- and that may even help you pick a good mutual fund.

This excerpt is useful food for thought when analyzing performance data of trend followers...especially when they are doing really well or really bad. The key is to think about how they typically trade.

Are You a Thrillionaire or a Willionaire?

In the June 24, 2006 WSJ, Scott Stearns authors 'Advisers Mine Clients' Personality Types Emotional Responses, Rather Than Assets, Affect Service and Marketing to the Wealthy'. An excerpt:

"In hot pursuit of the affluent, more financial advisers are focusing on the passions and motivations of their clients, rather than just the size of their wallets. For these advisers, it no longer suffices merely to know clients' favorite sports teams and the ages of their children. They want to know how a client's mind works -- and they are using a host of new "psychographic" tools to help them figure that out. JPMorgan Asset Management, a unit of J.P. Morgan Chase & Co., recently hired a New York-based cultural anthropologist to research what makes the affluent tick. The study, released to advisers in March, found that wealthy people generally fall into one of five categories, including "thrillionaires," who see their money as a means to splurge on fabulous objects and experiences, and "willionaires," who feel wealth brings a responsibility to improve the world and who are most likely to see their name carved into the side of a building. This kind of research influences the way retailers decorate stores and the kinds of homes real-estate developers build in planned communities. Pharmaceutical companies use it to target sales pitches to physicians. For advisers, it provides a framework for working with clients -- and selling them new products and services. An adviser might pitch a conservative asset allocation as "innovative and customized" to a thrillionaire client, said Susan Hirshman, a wealth strategist and managing director at JPMorgan. Drone on about "conservative investing," and that investor might flee to another adviser who better understands what pushes the investor's buttons. Similarly, a meeting at the fanciest restaurant in town might lead the "realionaire" client (thrifty, "Millionaire Next Door" types) to wonder if the adviser is charging too much."

This type of analysis doesn't suprise me, but it does scare me. "Feeding" bad habits, which I believe these efforts do, is not wise long-term strategy.

Smaller Minimums

June 25, 2006

Feedback on smaller minimum trend followers:

Hi Michael,

David B. Root Jr, CFP
CEO
D.B. Root & Company
Financial Planning
3100 Koppers Building
Pittsburgh, PA 15219

This is not a sales pitch from me as I don't know David. Just seemed like good information to pass along.

Why Trend Following Is Not Main Stream

Feedback from a reader:

Hi Michael,

Keep it up,
Mike

Orin Kramer: Chair of the State of New Jersey Investment Committee

June 22, 2006

Orin Kramer is Chair of the State of New Jersey Investment Committee and a General Partner of Kramer Spellman, L.P. managing private investment partnerships concentrated in public equities. He spoke the other day at a Managed Funds Association event in Chicago I attended. Some of his stark comments (paraphrased):

"When we drop 100 million in Microsoft over the course of a day, 14 million an hour, no one views it as a big deal. People accept the up and down, the volatility. But if a hedge fund drops 2%, it is a big deal. That is irrational."

On screening out volatility:

"We expect hedge funds to be non-volatile. It is irrational. By doing this you screen out all investment opportunities where there is volatility."

On correlation:

"Many of the people in the public pension world still don't get that adding a volatile hedge fund component (not positively correlated) to an existing portfolio reduces the portfolio risk."

While he did not say it expressly, Kramer's words for me point to why opportunities like trend following will continue to exist. With so many billions upon billions tied up in pension funds and with those funds often run by a 'herd' mentality (i.e. not necessarily the brightest bunch), chasing benchmarks and chasing reputation risk (i.e. afraid of doing something different than the other guy who is scared too) will keep those unpredictable trends coming.

Mike Norman Radio Show

June 21, 2006

I did Mike Norman's radio show today on the BizRadio Network. Mike is also a regular pundit for Fox News.

Mark J. Walsh: Trend Following Success

Mark J. Walsh was not a Turtle, but Mark was close enough to the Turtle experiment and Richard Dennis early in his career to learn the ins and outs. Now 20 years later, Mark still a relatively young man, has put together an impressive track record (PDF) as a trend following trader.

Elizabeth Cheval: Keynote at Managed Funds Association (MFA)

June 20, 2006

I was in Chicago today for the Managed Funds Association's Forum 2006. The lunch keynote was delivered by Elizabeth Cheval, Chairman, EMC Capital Management, Inc. and was titled 'Let's Get Negative! Correlation and the Case for Managed Futures'.

Cheval's presentation was easily one of the best I have seen in the industry. Tackling a subject like 'correlation' and making it user friendly is not easy, but Cheval hit the mark. Some highlights with more to follow in the next week:

1. She framed the conversation in two parts: 1.) Human Investment Psychology and 2.) The Mathematical Solution.

2. The psychology that led to the tech boom/bust influences our portfolios every day. The psychology that led to the tech bubble does not go away and it is still a useful example because it is in reach of short-term memory.

3. She outlined chronocentricity [from this book] or the inborn egotism that one's own generation is poised on the very cusp of history. Everyone should see why she was speaking of this.

4. Her definition of correlation: the nominal measure of the tendency for two assets to concurrently under perform or over perform their average returns by the same number of standard deviations.

5. You want negative correlation as much as you can get it in your portfolio as long as the components added are positive returns.

Long-Term Investing in a Short-Term World

June 19, 2006

Michael Mauboussin, Chief Investment Strategist of Legg Mason Capital Management (LMCM), authored this paper titled Long-Term Investing in a Short-Term World (PDF).

Toxic Trading by Janice Dorn

Janice Dorn, M.D., Ph.D. sent me this piece. I like it:

There is a Zen Koan that says: Don't just do something-sit there.

The most difficult thing for traders to do is to sit there and wait. Why? Because, we live in a society that is on a total dopamine, hypomanic binge. This is never more clearly manifest than by those who absolutely have to be in the markets at all times, desperately need to be trading and simply cannot wait. They are human do-ings, rather than human be-ings.

Continue reading Toxic Trading by Janice Dorn »

Masters of the Maligned

June 18, 2006

Since so few articles are written on short selling, take a read (PDF).

The Shift to Earnings; Huh?

Perusing Yahoo Finance tonight looking for some 'fun' logic I found this pearl:

"NEW YORK (AP) -- Wall Street has finally come to grips with the fact that the Federal Reserve is going to raise interest rates until inflation is well contained. Now investors will focus on whether those rate hikes are going to pressure corporate profits. There's very little economic data in the week ahead, which is not necessarily a bad thing. In recent months, Wall Street has shown a tendency to overreact to economic reports, even when analysts say the numbers are insignificant or inconclusive. The Fed's month-long tough talk on inflation has coincided with a month-long selloff based on inflation fears. Now, however, with the Fed all but certain to raise rates at its meeting at the end of this month, Wall Street's attention will turn to corporate earnings. This is "preannouncement" season, in which companies issue revised forecasts on their earnings. Preannouncements, which often aren't scheduled in advance, can be either good or bad, and can send a stock sharply higher or lower."

It's Sunday night. One of the largest portals for finance news just posted this comment...so what do you do with it? Do you buy something tomorrow? Sell something? Is this comment meant for stock traders? Bond traders? Commodities traders?

What does "tendency to overreact to economic reports" mean exactly? How do investors "focus on whether rate hikes are going to pressure corporate profits" or not? And if you are able to do this, what then?

I am confused.

Trendoscil System

At a presentation at Superfund's offices recently I met trend following trader Jean Jacques Chenier. Jean Jacques is the developer of the Trendoscil system (Alterama has the license to trade the Trendoscil system):

"The Trendoscil system is designed to make the bulk of its profit on long term trend following trades; the shorter time frame/counter trend improvements were implemented primarily to smooth the volatility in trend less periods."

An overview of the firm (PDF) and top 10 ranking (PDF). There is always something to be learned from other traders...

Cramer Blog Piece

June 15, 2006

Some feedback on Jim Cramer:

"Michael, I am not sure if you have already read this (link to blog), but I think you will find it of interest and a bit humorous too. Any thoughts you would like to share are welcome. Kind Regards, Muaad"

That is nice piece of fun writing, but did the writer need a bear market to start to doubt the wisdom of relying on Cramer's stock tipping?

Negatively Skewed Trading Strategies

June 14, 2006

An article titled Negatively Skewed Trading Strategies (PDF) by Glyn A. Holton is definitely worth reading. Well said. For those not following the logic here completely, take a read of Chapter 4 and 8 of Trend Following.

Some feedback on above report:

Michael: When I used to own an FCM, we had a saying for option premium sellers, "they ate like birds and shit like elephants". And they scared the crap out of us. Regards, Jack Zaner.

Thanks, Jack. Sometimes the short and simple sentence best describes it all!

Superfund Presentation at Fifth Avenue Office

June 13, 2006

Last night I gave a presentation to a lively group at Superfund's Fifth Avenue office. Aaron Smith of Superfund had invited me up to speak a few months back. True to his word he provided forum space and let me cover whatever trend following topics I saw fit. I give Aaron (and ultimately Superfund's CEO Christian Baha) credit as I brought up the full range of topics including positive stories about some of their competitors. Why do they allow this? In my opinion they are actively working at the big picture of providing education along with their hedge fund business model. Outside speakers like myself don't like to be constrained and they accept that. It is refreshing.

After the presentation I spoke with a writer from Reuters who covers the hedge fund space (he had read 1/2 of my book so far). He was probing more as he was not really 'getting' trend following. I put a quick chart on the white board showing a move from 50 to 150. I asked if he cared what the market was and why it went from 50 to 150 as long as he could be long. He agreed that he would not care if he could catch that move. But then, seconds later, he says, "but how do we know why it went to 150?" We went round and round. He kept coming back to the idea that there must be a need for knowing why the market moved. He rationalized that if you knew the fundamentals you could surely add that knowledge to trend following and do even better.

It was a great example of a bright guy not seeing the trend following picture just yet. We agreed to continue the conversation as I promised to get him over the hump.

A Culture of Risk

June 11, 2006

The odd thing about this article (PDF) describing Wall Street's culture of risk? Why don't the banks and other players have a plan to make money when shit hits the fan? Why is the unexpected viewed as something to manage and limit as opposed to being a great opportunity (trend following view)?

William Arthur Ward

June 10, 2006

Wise feedback:

"Hi Michael, I'm a trader in the Asian Markets and I've always been baffled at why many of my colleagues don't seem to understand how markets work. I just read you book, Trend Following, and now I understand just a little bit why. I have a friend who just finished his CFA examinations recently and after discussing with him my actual trading experiences as well as the ideas in your book, he mentioned that given the way finance is taught nowadays, it's very possible to pass the CFA examinations and not know the first thing about real, practical, and successful trading. By the way, I keep this quote from William Arthur Ward near my desk, and I think it perfectly captures the essence of trend following and trading. Best Regards, Doc"

"To laugh is to risk appearing a fool,
To weep is to risk appearing sentimental
To reach out to another is to risk involvement,
To expose feelings is to risk exposing your true self
To place your ideas and dreams before a crowd is to risk their loss
To love is to risk not being loved in return,
To hope is to risk despair,
To try is to risk to failure.
But risks must be taken because the greatest hazard in life is to risk nothing.
The person who risks nothing, does nothing, has nothing is nothing.
He may avoid suffering and sorrow,
But he cannot learn, feel, change, grow or live.
Chained by his servitude he is a slave who has forfeited all freedom.
Only a person who risks is free.
The pessimist complains about the wind;
The optimist expects it to change;
And the realist adjusts the sails."
- William Arthur Ward

Not at This Time

June 08, 2006

Some feedback from a reader explaining why trend following is not wise today:

"The problem is you will spend a lot of time and effort just breaking even on what are presently very stagnant markets. While it is true one might make 50% or more by joining the short sellers every time the markets panic, if one is uncomfortable with the added risks of short selling, one must find at least one home run long position once in awhile, e.g. 50%, 100%, etc. [I pick 100% just as a round number large enough to overcome the retarding effect of position sizing on that rare home run you might get by trying to trend follow in the chop.] What I am suggesting is that markets today are so correlated and so stagnant that you cannot find any long investment that will stand out far enough to get ahead of all the losing trades one has to endure in trend following this sort of market. Markets are very choppy and increasingly correlated because of globalized trading. "Low opportunity" as you say. I guess this is my point and criticism of trend following as a useful trading tactic at this time."

Thanks for the feedback. Comments:

1. Which 'markets' do you mean?
2. How do you define 'at this time'?
3. How do you explain the success seen here: www.jwh.com, www.wintoncapital.com, www.grahamcapital.com, www.chesapeakecapital.com, etc.? Are their results just 'luck'?

Michael J. Mauboussin: More Than You Know

June 06, 2006

Michael J. Mauboussin has a new book out called More Than You Know: Finding Financial Wisdom in Unconventional Places.

I was not aware of Michael's new book until he sent me a copy, but I feel silly for missing its release in April! Michael's writings have influenced me greatly over the years and many of his quotes are in Trend Following. He has the unique ability to break down the very complicated into the very simple. Read his new book if you like to learn! Avoid it if you like stock tips!

Mean Markets and Lizard Brains

June 05, 2006

Peter Borish had mentioned the book Mean Markets and Lizard Brains: How to Profit from the New Science of Irrationality by Terry Burnham to me some time back. This interview with the author jogged my memory: PDF.

"Narrow Minded Jackass" Follow-Up

June 04, 2006

Recently I had a reader call me a narrow minded jackass for my $1 contest. That comment brought this rather sarcastic feedback from another reader:

"In order to prove that 'predicted technical analysis does not work' , we need to define 'predicted technical analysis' and 'work'. Does the common technical phrase 'a flag always flys at half mast' mean that if you happen to pick the right breakout from the flag and it travels exactly as high as the run-up to the beginning of the flag, then I guess it 'works', depending on your measurements and of course adjusting for a little bit of slippage and such, and you know if it comes within 1 point of your target well that's close enough, right? Or maybe it's that 5th wave in the Elliot wave format that pushed up exactly 0.618x the length of the 1st plus the 3rd wave, or is it just the 3rd wave, I forget? Oh yeah that head and shoulders, you know that's a sure winner because when that breaks down from the right shoulder you know for sure that the market will dive to the exact length of the measurement from the base to the peak of that head and shoulders. Oh yeah, I just love trading the support and resistance bands because they are always spot on - so predictive like shootin fish in a barrel. This is why trading is so blessed easy it almost pains me to take so much money this way- you know that MACD, it's like reading tomorrows Wall Street Journal - yeah there's no way you'll ever prove this stuff doesn't work, I mean just look out your window there are guys and girls drivin Ferraris all over the world because of all the riches they have claimed from predictive technical analysis. Good luck with this one - oh hang on a sec, I've gotta take this call from Nostrodamus, he's gonna tell me what orders to place Monday morning. Just another narrow minded jack ass [here]."
Mike Marchese

The reader who originally wrote in with the 'jackass' comment saw the above response and responded:

"Your response to my comment that you are a narrow minded jackass not only reinforces my belief but tells me that you are also delusional. I recommend you see a Psychiatrist."

This subject appears exhausted!

Best Answer for $1 Contest

Best feedback so far on my tongue and cheek $1 contest:

"Michael, That chart looks like my Uncle Vinny's EKG after a big meatball parm and liter of Coke. CFA = Constantly Fumbling for Anwers. My guess is as good as any - literally."
MRM (Martin Trading)

Canadian, Texas Visit

June 03, 2006

Salem Abraham (second from right)

Took quick trip down to Canadian, Texas on Thursday and Friday to visit with Salem Abraham (trading around $150M as a trend follower with a near 20 year track record). More to come about the trip, but it was a starting point for my second book now underway.

Canadian is in the Texas panhandle. It is a small Town, but an absolutely great place to visit. The picture above, at the Hemphill County Airport, is right before most of us headed back to Dallas.

The Way to Travel the Country When Living in Canadian, Texas!

Shaun Jordan, of Abraham Trading, Demonstrates His 'Skills'

Abraham Ranch; Article on Salem & His Brothers (PDF)

Getting Around the Ranch Made Easier

Trading in Canadian, Texas

$1 Bet Continued...

June 02, 2006

Feedback in today:

"I read about your $1 contest. I've decided to give you 1 million dollars if you can prove that predicted technical analysis does not work. P.S. You are a narrowminded jackass!"

Words Mean Things

June 01, 2006

From yesterday's headlines:

Stocks Climb As Oil Plunges
Wednesday May 31, 11:05 am ET
By Christopher Wang, AP Business Writer
Stocks Climb As Oil Plunges; Energy Market Welcomes Latest Move by U.S. in Iran Dispute

NEW YORK (AP) -- Plunging oil prices pushed stocks sharply higher Wednesday as the United States' latest move to settle the dispute over Iran's nuclear arms program eased the energy market's worries about a supply cutoff from the petroleum-rich nation. The pullback in crude oil helped calm inflation jitters as investors grew hopeful that the minutes from the latest Federal Reserve meeting would shed light on the outlook for interest rates. Traders have been scouring for clues on whether to expect higher lending rates after the Fed said in early May that more rates hikes could be needed to battle soaring energy prices.

A 1% drop in oil is a "plunge"? Huh?

How can you, Christopher Wang, know for sure that this oil "plunge" calmed "inflation jitters"? How did you determine that? Is that your opinion or some form of research you conducting in the last 24 hours? Yes, I am being sarcastic, but don't you have any need to connect your words to some form of measurable reality?

Global Sell Off

An email was sent to Ed Seykota:

Dear Ed, the "Global sell off" [is] all over my newspaper these last few days. I am right in asserting the following *the long-term trend is up* until I know otherwise (i.e. an extended period of downwards trading) this still remains true.

Ed Responded:

There is no such thing as the trend. Some of the shorter indicators are down while some of the longer ones are still up. At some point in the non-existing future, we might look back into the non-existing past (now) and notice the exact numerical values of all the various trends that we cannot now measure.

All markets trend. This writer assumes Seykota will know which market he is speaking of.