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

"I Made It Up"

August 31, 2006

Michael Gibbons of Gibbons Trading adds to the "price":

Michael,

I stopped looking at news as something important in 1978. A good friend of mine was employed as a "reporter" by the largest commodity news service at the time. One day his major "story" was about sugar and what it was going to do. After I read his piece, I asked: "Gary, how do you know all of this?" I will never forget his answer...he said: " I made it up."

I have looked only at price since 1978.

Best,
Michael Gibbons

Don't Take the Bait

August 30, 2006

Hi Mike,

Regarding your recent post about the trader who claims to be a trend follower, but then tries to bait you into claiming something negative about trend following – I’m not sure what to make of these people, but, as a trend follower, I am pretty happy they are around – after all it’s their doubts and fears that fuel my next potential gains – it’s their indecisiveness, their need to change, find the next new system that “works” – it comes back to human nature and discipline – the need to be right is so strong in so many – and the discipline necessary to stick with a sound trading system is so difficult for so many – otherwise your “hall of fame” of trend followers would 40 pages long – all I need to do is look at the charts for the past year – hmmm – copper – got it – trend – check – silver – got it – trend – check – sugar – got it trend – check and look at that – sugar again right now has been trending down – got it – trend – check – oh yeah – orange juice – and ummmmm – oh yes the 5 yr note – cattle – hogs – there have been and are trends going on right now – I have 14 positions on and some of them are into a trend and others may be starting a new trend and others may turn around for losses – I DON’T KNOW – but I do know my downside on each of these positions and I do know that I had some tough months of returns in may, june, july – and I am relatively new to this – my longest account has only been active for 14 months – is trend following dead? – If trends cease to exist then markets cease to exist, then there is no game except selling volatility, then everyone gets into that and their heads get taken off and then when everyone walks away, the trends come back and over and over – supply and demand – cycles- get back in – who knows – its uncertain – embrace it! - I have a ton to learn and that will always be the case and no matter how much I think I know, I will never know where the market is going … but I will know what to do when it gets there (I think that was a Bill Eckhardt line, in some shape or form).

Thanks,
Michael Marchese

More Old Pro Wisdom

August 29, 2006

I have developed a friendship with an old pro trader who sends me regular insight. A recent email in:

Hello again everyone-due to other commitments today will be my last "morning market comments". As most of you know several months ago I was invited to be a ghost analyst for a well-respected daily newsletter writer in the futures industry. For a number of reasons I decided not to get involved but in my trial period I found a number of things about myself I had never recognized before. Some things I learned are not necessarily about me per se but more about trading and I learned a few things about some of you. My readers included two successful commodity trading advisors, a surgeon, a real estate developer, a successful businessman, a successful salesman, and a federal law enforcement agent. The point here is that people from all walks of life have an interest in trading on some level.

A few of the things I learned are as follows:

#1 there is a huge gap between market analysis and trading markets to make money.

#2 There is no relationship between being "right" and making money.

#3 While markets are not predictable people are.

#4 Anything can happen in the markets so how worthwhile is a market opinion?

#5 Having a definable game plan and following it will overcome poor analysis.

#6 I know some very rich traders but I have yet to meet a rich analyst.

#7 You should never give out market advice because readers don't need your bad advice and they will ignore your good advice so don't give them any advice.

#8 A correct market opinion does not answer the questions of how and when do I place a bet, when do I know I am wrong, how big is my bet in terms of dollar or percent risk, and most important how do I manage my trades when they are working.

#9 Some very smart people think the stock market is going up. Some other very smart people think the stock market is going down. Since I don't have a clue what the stock market is going to do I totally agree with both opinions.

#10 Managing the money and more importantly managing the trade is more important than being "right".

#11 A good trade is a trade which was entered and exited following one's rules regardless of the dollar outcome be it a gain or a loss.

#12 Most newsletters offer both sides regarding market direction. Whichever way the market goes will then be highlighted in subsequent newsletters as if the writer new what was coming.

#13 The more negative email you receive regarding a market opinion the more you should bet.

#14 If you receive emails endorsing your view you might want to re-think your opinion.

#15 You learn very little "watching" someone else trade and you might very well harm yourself as a trader by following the advice of others. Be your own man or in one case lady!

#16 Keeping a trading diary on a daily basis will teach you how you think. Be honest and don't edit your diary in hindsight. Again trading is not about right and wrong but it is about doing and not doing.

Good trading to everyone!

How Change Happens

A reader sent me this excerpt from John Mauldin. He touches on analysts' propensity to offer explanations for every market move:

"To trace something unknown back to something known is alleviating, soothing, gratifying, and gives moreover a feeling of power. Danger, disquiet, anxiety attend the unknown - the first instinct is to eliminate these distressing states. First principle: any explanation is better than none... The cause-creating drive is thus conditioned and excited by the feeling of fear ...." Friedrich Nietzsche

"Any explanation is better than none." And the simpler, it seems in the investment game, the better. "The markets went up because oil went down," we are told. Then the next day the opposite relationship occurs. Then there is another reason for the movement of the markets. But we all intuitively know that things are far more complicated than that. As Nietzsche noted, dealing with the unknown can be disturbing, so we look for the simple explanation. "Ah," we tell ourselves. "I know why that happened." With an explanation firmly in hand, we now feel we know something. And the behavioral psychologists note that this state actually releases chemicals in our brain which make us feel good. We become literally addicted to the simple explanation. The fact that what we "know" (the explanation for the unknowable) is irrelevant or even wrong is not important to the chemical release. And thus we look for reasons. And that is why some people get so angry when you challenge their beliefs. You are literally taking away the source of their good feeling, like drugs from a junkie, or a boyfriend from a teenage girl. Thus we reason the NASDAQ bubble happened because of Greenspan. Or a collective mania. Or any number of things. Just like the proverbial butterfly flapping its wings in the Amazon that triggers a storm in Europe, maybe an investor in St. Louis triggered the NASDAQ crash....

What's the Difference?

What's the difference between the junk mail below and CNBC?

Seriously.

There is none in my mind.

Make no mistake: Our mission at Traders Daily is to sift through the thousands of underperforming companies out there to find the golden needle in the haystack. The micro-cap diamond that can make you a fortune. More often than not, the stocks we profile show a significant increase in stock price, sometimes in days, not months or years We have come across what we feel is one of those rare deals that the public has not heard about yet.

We rate this ENERGY DEAL 10/10 on the radar and predict it will trade with huge momentum early next week. This stock trades daily, has constant news and it's RUMORED something big is gonna be released early next week! Put this one on your watchlist and see it fly on up!

The Hazards of the New Online Collectivism

August 27, 2006

Jaron Lanier recently wrote an essay called The Hazards of the New Online Collectivism. A summary:

"The hive mind is for the most part stupid and boring. Why pay attention to it? The problem is in the way the Wikipedia has come to be regarded and used; how it's been elevated to such importance so quickly. And that is part of the larger pattern of the appeal of a new online collectivism that is nothing less than a resurgence of the idea that the collective is all-wise, that it is desirable to have influence concentrated in a bottleneck that can channel the collective with the most verity and force. This is different from representative democracy, or meritocracy. This idea has had dreadful consequences when thrust upon us from the extreme Right or the extreme Left in various historical periods. The fact that it's now being re-introduced today by prominent technologists and futurists, people who in many cases I know and like, doesn't make it any less dangerous."

I would argue the hive mind in some way or another has always been there. I would also argue that the hive mind is what allows traders like trend followers to profit in the zero sum game.

Bill Eckhardt Wisdom

August 26, 2006

A good piece of wisdom from Bill Eckhardt:

"If you make a bad trade, you have money management, you have a whole bunch of things that will come to your aid, and you're really not in so much trouble if you make a bad trade. But if you miss a good trade there's really nowhere to turn. If you miss good trades with any regularity you're finished, you're doomed in this game."

Charlie Rose - E.O. Wilson & James Watson on Charles Darwin

August 24, 2006

This video is unrelated to trading. It is an hour on the life and work of Charles Darwin with James Watson, chancellor, Cold Spring Harbor Laboratory, and E.O. Wilson, professor emeritus, Harvard University. One of the best one hour pieces of video I have seen in years. Free on Google Video.

Robert Kiyosaki - Good Line

August 23, 2006

I caught a good line from Robert Kiyosaki recently:

One of the more financially dysfunctional notions I hear from poor people is that "money doesn't make you happy." I don't know about you, but I'm much happier when I have an abundance of money.

Analysis BS

August 22, 2006

It is rather different running a site like this. Many people expect and frankly want tips. If they don't see tips, they actually question the substance. Go figure. On top of that, others want analysis, whatever that means exactly. Daily comments about what the market did? No, thanks, I would rather watch grass grow or sniff glue.

Every top trader I have met works like hell to develop a philosophy. They convert that market philosophy to rules. Those rules are often then reduced to code a PC can comprehend. After that, they stand back and see if their whole procedure acts as expected. Tell me, if you build a system that gives you an entry and exit, tells you "how much" to bet while along the way adjusting to your current capital and the market volatility - why does there need to be more analysis?

Henry Luk from New Zealand

August 21, 2006

Some feedback about a recent post:

Hi Mike, I just read your "The Elephant in the Room" post. He didn't grasp the concept AT ALL...People love to predict. People love to be right. People love to hang on to the past. People love to control EVERYTHING. You see it everywhere. Not just in the market. People lose their loved ones/make mistakes and they live with guilt and regret and hang on to it forever. People think they can control certain things, but it turns out they can't. People hang onto losing relationships for years. That's human nature. Trend following teaches that this is NOT the way. Because if we do this way, we simply live in pain forever, everyday, every second. And why choose to live in pain? We have two choices everyday when we roll out of bed, live in pain or live in happiness. I would like to live in happiness thank you...'Trend' does not exist. It ONLY exists in hindsight on the chart, Trend followers do NOT follow trend. "Following trend" has the smell of prediction in it. Trend followers simply just follow "the present". We buy because the market is going up NOW. We sell because the market is dropping NOW. We have NO IDEA if it will keep rising the next second. We simply don't care! We don't need to care because of money management strategies and "homework" on system design and back testing, etc. We should live our lives in the same way. There is only present. There is no past. The past is gone, and the future hasn't happened yet. You can make love to your wife tonight, but that doesn't mean she won't divorce you the next morning. You lost your loved ones in the past, but that doesn't mean you can't find a happier way to live now."

Top 10 Ways To Lose All The Money In Your Trading Account In 30 Days Or Less

August 20, 2006

I came across the list below from 'Craig' here. It is a great list:

Top 10 Ways To Lose All The Money In Your Trading Account In 30 Days Or Less - Guaranteed!

#1 - Absolutely, without a doubt, FORGET about managing your money. Don't worry about how much you can lose on a trade. Only think about how much loot your gonna make. Then start planning that trip to Fiji!

More Insights from An Old Pro

August 19, 2006

A good piece of insight recently shared with me from an old pro with 30 years trading experience:

"I guess most readers are familiar on some level with the sport of hunting. I am sometimes amused by the new outdoor channels portrayal of the sport of hunting. Jackie Bushman has a nationally syndicated show from Alabama that weekly portrays the harvesting of trophy bucks. A buck is a male deer for you who are somewhat challenged in the sport of hunting. Almost every week a trophy animal is harvested on the Bushman show. To the novice deer hunting appears to be simple and effortless. Of course what the cameras and most certainly the promoters never reveal is the countless hours of scouting for trophy deer that go into the eventual production of the show. So what's my point and how does all this relate to trading. Sometimes in trading there just aren't many trophies to be found - a trophy in the sense being a trending market. These times separate the great traders from the not so great traders. Over my 30 plus year career I have witnessed numerous "times like these". The good news is that they don't last forever and my bet is things are about to change. Trend followers have had a pretty tough time lately but tough times don't last but tough people do. The next question I often receive is "where is the next great trading opportunity?” Not to be a wise ass but if I really knew that I probably would not be sending this to you today. Well I might because this is fun for me and I hope educational for you. I enjoy teaching almost as much as trading. Trust me on this there are some very big trades coming and with hard work and patience you can catch them just like a real trophy deer hunter does."

Don't take his last sentence as a prediction, it's not. He is simply pointing out the reality of trends.

Not What to Think

August 17, 2006

A reader forwarded this to me today:

Over the next 1 to 3 years the macro fundamental forces driving global currency markets are unlikely to alter significantly. We really are in a 10-15 year period, that started 7 years ago, of a shift in global investment perceptions away from being U.S. centric to being more balanced globally. At the same time, and to some extent related to global portfolio reweightings, sustained and strong economic growth is becoming more widespread. China and India are the much quoted examples, but the phenomenon is more general. As these once disparate and U.S. centric for exports economies continue to grow, they are doing more and more trade with each other. Gradually the rest of the world is moving away from its dependence on the U.S. This process has several decades to go, but markets tend to pre-empt, hence the U.S. dollar is already well on its way lower. In this environment any high yielding currency is going to do well, especially if it is the major financial center. Therefore a 2-3 year forecast for Sterling to be touching 2.2000 is not unreasonable.

Not trying to be a downer or crank. But I do find it instructive for those folks unfamiliar with trading to read 'not what to think'.

Old Pro Insight

August 16, 2006

The feedback below is from an old pro trader. The excerpts he sent and his feedback about those excerpts are listed. As an FYI, he knows Jones, hence the lack of formality:

***

Hi Michael, I thought it important to share some conclusions i have been able to reach from my latest batch of newsletters and research in a few markets I follow [that came across my desk].

U.S. stocks: "We remain long term bearish but short term friendly" to this ongoing developing trend. "If the market goes below 11130 basis the cash dow it is going down otherwise it could easily rally to 11400 or maybe even 11700."

Boy is that some good insight.

Sugar: "We remain committed to the bull camp in october sugar and are currently looking for a place to ad to our existing long position at 16.42. Some october calls are reaching extremely low prices."

No shit sherlock! What did Paul say about "losers averaging losers"?

And finally my favorite: "Risk management is the most over rated ingredient in successful trading. We never recommend risking more than 25% of one's trading capital per trade. Great traders just know when to step on the gas."

Dreary Decade Ahead?

August 15, 2006

From Yahoo Finance (CBS Marketwatch) tonight comes the eye catching title "Stocks may face a dreary decade ahead" (PDF). Whether this author is right or wrong, 19 years from now...who cares? No one with an ounce of sanity would use this article as a guide for anything. I would advise anyone who wants to play games with statistics, to actually play a game designed to deal with whatever eventuality comes down the pike...and forget predictions. That will require a more honest statistical thinking.

J.T. McPherson Asks Questions

J.T. McPherson sent me in the following article in 3 parts:

Part 1
Part 2
Part 3

His hand written notes are just the types of questions I would ask!

Fun in Advertising and First Time PC

August 12, 2006

While doing some research at the US Library of Congress for a new book, I came across this ad (PDF) and others. That ad is straight from Commodities Magazine (now Futures) circa 1977 or so.

Also, this one from 1978 (PDF), about what you can do with a 'computer', is a blast from the past.

Ajay Jani Passes on the Wisdom

August 10, 2006

I met Ajay Jani at a Superfund event in early summer. Ajay, who is not affiliated with Superfund, trades out of NYC and passed along to me tonight a recent debate he had:

Michael, I thought you'd get a kick out of this story. I was having a discussion with a dyed-in-the wool fundamentalist. No amount of information regarding the merits of trend-following or the examples of success using the strategy would sway this person from the view that nothing matters except the fundamentals. Eventually he brought out the old chestnut:

At that point, he gave up and shrugged, though I'm still not sure he's convinced! Best, Ajay

Independent Traders v. Goldman Traders

I was talking the other day with an old pro trader about the comparison of independent minded traders, like the trend followers mentioned in my book, to in-house traders at the likes of a Goldman Sachs. His comment:

"The lack of accountability for the in-house traders [is hard]. Their mess-ups are hidden in the rest of the pile. My track record was there for everyone to see...the institutional guys make a lot of noise when they hit but their mini crashes never make the news. I have always felt on some level the big guys let you know what they are doing or actually have done when it supports their market position. CTA's [trend followers] are really under the microscope every day performance wise and I am sure in house traders have supervisors that watch them but psychologically I think they are world's apart."

UVA Reading List

August 09, 2006

It is always good news to get a book into the Universities - they are tough nuts to crack. This feedback in from a noted professor at the University of Virginia:

"I enjoyed reading your book [Trend Following] especially chapters 2, 5, 6 and 8. In fact, I added your book in 2005 to a list of suggested readings for students in my Financial Trading class."

Execution Vs. Strategy

August 08, 2006

From Fast Company an excerpt worth considering:

Execution will always be more important than strategy. Actions speak louder than words. A fair-to-middling strategy exceptionally executed will almost always yield better bottom-line results than a great strategy poorly executed. A great strategy never executed -- and it happens a lot more than any of us would like to admit -- is a lame exercise in futility. [For example] John McKay had a track record as the highly successful coach of the USC Trojans [and had moved on to coach in the NFL]. A sportswriter caught McKay right after a particularly ugly loss:

He responded: "I'm in favor of it."

Just do it was McKay's message. No excuses.

Man Financial Family Tree

I found this article about Man Financial (PDF) from a few years back interesting.

K.I.S.S. of Trading

August 06, 2006

Janice Dorn sent in this piece tonight:

"Emails from traders and investors of every ilk come to me on a daily basis. I am grateful, and urge you to keep them coming, as you inspire me, challenge me and force me to think. Everyone has a different way of being in the world and...as a logical corollary... in the markets. I get charts, graphs, opinions, links to articles, and more opinions. So much lately has been what the Fed will or will not do and how it will affect the precious metals and the dollar. I work hard every day to prevent my head from spinning, keep it attached firmly to the neck area and to attempt to filter out the signal:noise ratio."

Continue reading K.I.S.S. of Trading »

August Futures Magazine

I have an article in the August issue of Futures Magazine. Drop me a line with feedback. I welcome feedback from all comers, ranging from the super smart out there to those crazy ones still living in mom's basement.

Returns Down on Purpose?

I posted a quote from Paul Tudor Jones the other day. But after thinking about it, I wanted to add some more comment to it.

I often hear the cry, "trend following returns have decreased!" In many instances they have, but for a simple reason: the client wanted it that way. To make more money you apply more juice (see leverage). Great trading, any great trading, will always require more risk and result in greater drawdown if you want to make big money. Many clients today, many of the institutional investors are plain happy with 10-15%. That's all they want for an assortment of reasons, i.e. peer pressure (no incentive due to competing with benchmarks), or even just not that smart about the benefits of absolute returns. Paul Tudor Jones, while not technically a trend follower, has traded futures from a macro perspective for decades. He says it clearly:

"Our returns have definitely flattened out since the '80's. But if you look at my risk adjusted returns, they're very similar and I'm probably the same exact trader as I was 15 years ago. What's different has been my own personal appetite for risk and volatility. I think that probably happens with a lot of people as they get older. Everything is a function of leverage, how much of a draw down are you willing to tolerate, how much leverage do you want to put on. When I was younger, I had much greater draw downs, much greater draw down frequency, much greater leverage. So again, I'm probably the exact same trader as I was 15 years ago, it's just less risk, less return."

A Trader's Train to Wall Street, Conn.

August 05, 2006

From the NY Times today:

"Thousands of young financial workers stream into Grand Central Terminal every weekday morning. But many are not on their way to offices on Wall Street or in Midtown. Instead, they are crowded into trains for Greenwich, Conn., which has emerged as the home of the ballooning hedge fund industry. The center of power in finance has shifted in recent years, and in one sense that shift is geographical. Some of the most powerful traders in the market can be found miles away from Wall Street, in Greenwich, Stamford, and Westport, Conn. 'If you look up and down the train line in Connecticut you will see all the hedge funds concentrated right along the line,' said Thomas Torelli, a corporate real estate agent in Greenwich. Those funds are there because their founders and top managers live nearby. But thousands of their employees do not and as result do what to the rest of Wall Street is a reverse commute. The trains leaving Grand Central between 7 and 8:30 a.m. are packed. Most seats are taken and conversation is sparse. Unlike Wall Street commuters, many are not wearing suits. Yet like the Wall Street crowd, some are working furiously on their BlackBerrys and laptops. A little less than an hour later, when the train rolls into Greenwich, workers stream out of the train and walk to their nearby offices. 'Greenwich is quiet, peaceful and clean,' said a young hedge fund employee on the train who lives in Manhattan. 'But I am 24 and single - I couldn't imagine living in Greenwich.' He spoke on the condition that he and his firm not be named because he was not authorized by the hedge fund to speak to reporters. Many other commuters declined to comment for the same reason. Hedge funds are notoriously secretive organizations. They will not disclose who their employees or investors are, much less their strategies. Now, apparently, how their employees commute is off limits, as well."

Au contraire, strategies are only so unknowable. The performance data of whatever hedge fund always offers a big clue...

Pure Talent is Not Enough

If talent is THE key to success, then explain, for example, Enron:

“Enron was the ultimate “talent” company bringing in a steady stream of the very best college and MBA graduates to stock the company with talent. During the nineties, Enron was bringing in two hundred and fifty newly minted MBAs a year. Once at Enron, the top performers were rewarded inordinately, and promoted without regard for seniority or experience. Enron was a star system. “The only thing that differentiates Enron from our competitors is our people, our talent,” said Ken Lay, Enron’s former chairman and C.E.O. As another senior Enron executive put it, “Creative Destruction - We hire very smart people and we pay them more than they think they are worth.”

The Turtles, for example, were not all about ‘talent’ either. Talent, like at Enron, insures nothing. There is always something ‘more’ to success. If IQ was the determining factor, then every Harvard MBA would be super rich.

Penny Stock Hype

From Yahoo Finance today:

Technically speaking, a "Penny Stock" is any stock that trades at less than five dollars a share. Many retail investors shy away from this market not knowing that there are many high quality companies that fall into this category. "We really like the opportunities in the small cap stock market," said William McKinley, President of Investing Systems. "When traders are looking to get into stocks that can deliver hundreds, or even thousands of percent return, they have to look at penny stocks."

That last line kills me. Fantasy Island would be my response. No ONE can consistently deliver thousands of percent return.

Paul Tudor Jones Insights

August 03, 2006

A few pieces of Paul Tudor Jones' insights. First on school:

"In 1976 I started working on the floor as a clerk and then I became a broker for E.F. Hutton. In 1980 I went strictly on my own as what they called a local and did that for about two and a half years and had two and a half wonderfully profitable years, but I really got bored. I applied to Harvard Business School, got accepted and was about to go. I literally was packed up to go and then I thought, 'this is crazy', because for what I'm doing here, they're not going to teach me anything. This skill set is not something that they teach in business school. So I didn't go, I stayed, but I was really bored because there wasn't the personal interaction that was something that I craved and having colleagues and being in a clean atmosphere and that was when I started my fund. All through growing up I've been involved in team sports and fraternities and in school I was involved in a whole variety of activities all of which were team oriented and when I was on my own I was printing money every month, but I wasn't getting the psychic satisfaction from it."

On the ups and downs:

"He was the toughest son of a bitch [Eli Tullis] I ever knew. He taught me that trading is very competitive and you have to be able to handle getting your butt kicked. No matter how you cut it, there are enormous emotional ups and downs involved.”

Investmental Illness: A Guide to Getting Well

August 01, 2006

Forget the specific trading advice in this article (PDF), which is circumspect, but concentrate on the psychological aspects - which are universally right. An excerpt:

"An irrational and frequently obnoxious overconfidence in one's own investment prowess, this narcissistic condition is so named because it is far more common among men than women. The ailment has been well-known among women for some time but was first quantified by researchers Brad M. Barber and Terrance Odean. Looking at data from 45,000 different investors between 1991 and 1997, Barber and Odean found that overconfidence in trading ability caused men to trade more often than women -- a lot more. The men in the sample, all told, traded 45 percent more on average than women. As a result, the increased transaction costs and taxes associated with frequent trading shaved 2.45 percentage points off men's total returns every year, compared with just 1.75 percentage points for women. The thing is, men and women look at money in different ways, says Nancy Langdon Jones, a financial planner who practices in Rancho Cucamonga and Claremont, Calif. "For women, money means security. For men, it means power." Matt McGrath, a planner with the Miami area wealth management firm Evensky & Katz, agrees. "Most of our couples seem to fit the stereotype," he says. Men tend to be more aggressive, while women are often more conservative and circumspect -- sometimes to the extent that they separate their accounts completely."