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

Video from CLSA Hong Kong Conference

October 31, 2006

This video clip excerpt posted on YouTube.com is from a presentation I gave at a September 2006 CLSA investors conference in Hong Kong.

A Review From Mars, Part Deuce

October 30, 2006

Feedback in last night:

In "A Review From Mars", Mr. Covel artfully dodged to address the real issue with his Trendfollowing advocacy: survivorship bias. Unless Mr. Covel can convincingly demonstrate that his profiled trades are not just "lucky monkeys", I have a hard time suspecting that Mr. Covel is not just selling snake oil.

I believe that the notion that all trend followers who win are lucky survivors is not accurate. Sometimes those so love in math forget that you have to wake up each day and put your shoes on...and go make it happen. There are concrete reasons for failure and concrete reasons for winning. If we go down the logic I think you are heading, you would argue all great achievement in life is the result of the winning lucky monkey.

More feedback:

Michael, I think the point at which critics of your book and trend following in general get mixed up is the fact that you make the methodology of trend following sound so simple, especially in relation to other strategies such as fundamental analysis. The fact of the matter is that it is relatively simple, but that's not the problem. What they miss is that trend following like any other successful trading strategy requires sometimes enormous amounts of discipline, patience, and persistence, and not everyone has it. Anyone who has spent any significant amount of time developing, testing, and/or trading a trend following strategy can see the potential of such a strategy (my guess is that your critics haven't done so). However, these strong results in simulation or in 'paper' trading mean nothing without the qualitative tools to make it happen consistently in 'real' trading. The problem is it's so much more comfortable for your "lucky monkey" critic to use and blame someone else's blackbox strategy (fundamental analysis) when it fails, than to know that success or failure ultimately rests in your own hands. Keep up the good work.

Huh? Part 2

October 29, 2006

I recently posted a reader comment and my feedback. That post generated this response:

"In your answer to the gentleman or lady regarding fundamental vs trend following trading, you berated him/her for seemingly knowing the difference, but hedging. You stated that your task was to educate. What education did you set forth? I must have missed it."

He says trend following works, says trend following performance data is accepted, then says you need fundamental trading too because reality is far more complex than any one model. Isn't that a rather stark contradiction? Isn't the education the fact that this view of adding fundamentals to trend following is not doable except by the lone superstar here or there?

A Review from Mars

October 27, 2006

I saw this review recently about Trend Following:

"This is a poorly written book that is riddled with survivor bias. Furthermore, it never gives specific advice regarding how to find the trends to follow. Instead, it just profiles the heroics of guys who could see big trends coming (by some means other than systematic technical analysis) and won big by guessing right. What a frustrating piece of junk."

I do not profess to be a literary giant and people will have different tastes for different writing styles. Fair enough. But the notion that the traders profiled in Trend Following (and trend followers not profiled) were "guessing" right for 30 years and were not using systematic technical analysis - is asinine.

Now in all fairness, maybe this reviewer doesn't get what trend following is? I found another review by this same person for another book. It said:

I'm in the process of getting serious about investing as returns from existing investments are now a sizable part of my annual income. This book's main argument, that the stock market is going to be flat, at best, over the next decade seems pretty persuasive. The most persuasive reasons for this are:

I'm interesting in joining a club of serious investors who want to pool what they are learning in the areas of small-cap and value investing."

It is fair to say this reviewer doesn't get it. Frankly, I would like him to see it, but I do it find interesting how some people simply miss what trend following is and how it works.

Why Fundamentals? #2

Feedback from Nick Glydon:

"I believe people still "prefer" fundamentals because they are striving for intellectual stimulation. You don't sound very interesting at a cocktail party if you say Glaxo is going down "just because it is", whereas if you can talk about cancer drugs, etc, etc, blah, blah people think you are interesting. Goldman's salespeople can talk for hours about cancer drugs, Chinese GDP, and US housing data - they too like to seem "intelligent." You have to ask "what are you trying to get from markets, money or perceived intelligence?" By the way, I am an technical analyst working for an institutional broking firm in Europe. Plenty of clients do follow our trend following advice, but very very few follow it exclusively - most try to "marry it" with fundamanentals of one sort or another. I also believe trend following works better in equities than in most other markets, as there are very many individual stocks which double, and double again - it doesn't happen that often even in commodity markets. I've been a trend follower for 20 years! I like your book by the way, but the one I give the most to clients is still the O'Shaughnessey one - proves better to my audience that momentum matters. Cheers, and keep up the websites - very useful stuff."

Why Fundamentals?

October 26, 2006

Feedback:

"Michael, I have been a trend follower for a couple of years now. Your book slapped me upside the head sufficiently to get me out of my fundamental analysis ways and see the light. There are a couple of things I still don't understand though. Why haven't more people abandoned traditional fundamental analysis, which has no consistency at all, in favor of trend following? I'm actually glad this hasn't happened because then all us trend followers might be screwed because all the money would be moving together, but how is it that the old fundamental money still dominates the financial market industry? Is it just that firms like Goldman have so much riding on the fundamental investment fallacy that they don't want people to change their investment strategies, because they have essentially figured out the way people react to stock fundamentals and can score big profits off of it with big money bets? Not only that, but how do fundamental analysis firms still exist in today's market?"

Isn't Goldman the exception? With that kind of access and money, are they different? Many think they are. Many think they are invincible. Others say exactly what you say, not as much because of fundamentals, but rather because of extensive leverage in an assorted collection of mean reversion strategies. Time will tell.

One Man's Ten Commandments

October 25, 2006

One man's Ten Commandments (PDF). An excerpt:

"Discipline trumps conviction. No matter how strongly you feel on a given position, you must defer to the principles of discipline when trading. Always try to define your risk and, above all, never believe that you're smarter than the market."

Hedge Funds and Risk

A whitepaper (PDF) titled "Does a Change in Risk Regime Spell Trouble for Hedge Funds?"

Huh?

October 24, 2006

Feedback from a reader who I have been debating with in email:

"Nobody disputes the virtues of trend following trading. Its performances are clearly recognized. The point here is that computer trading models sometimes fail. You recognized that too. Reality is more complex than any model. The problem with gold is that it is a lot influenced by political and economic factors. Obviously these factors are hard to quantify in a model."

No knock against this man personally, but he has no clue. On one hand he is admitting the viability of trend following, but in the next breath saying you need a fundamental understanding too. I say, "Shit or get off the pot." These two strategies don't marry successfully. You are either or.

But perhaps the reason I find his post so useful is that he truly believes he gets what trend following trading actually is, but within a few more words, demonstrates his lack of any conceptual understanding. I post not to pick on him, but rather to educate someone else who might be confused as well.

What It Takes to Be Great

October 23, 2006

Regardless of the life endeavor, greatness leaves a trail. What does it take? A good read from CNNMoney.com (PDF) on the subject.

More Faulty Logic

October 22, 2006

This post brought in this feedback attempting to explain why certain opinions should be valued:

"Well, given that some hedge funds go bust, his message is quite credible. When he backs up his opinion with Mr. Volcker's opinions, he gains additional credibility."

'Opinions' mean more than decades of performance data by systematic traders? Explain that logic to me.

Stop Making Sense

October 21, 2006

I received this feedback:

"Jim Sinclair said that just relying on computers and computer models cannot be a substitute for the real knowledge of the markets. What is your opinion about that?"

I responded: "Do you think his opinion makes sense given the public performance data of the traders you say he criticizes?"

He responded:

"Well, he seems to know a lot about gold and gold markets. He also seems to have forecasted correctly the present gold price action. It is not a bad idea to read first his comments."

Here are the comments in question. I don't understand how these comments refute trend following performance data.

Trading is not about hero worship. Meaning just because someone of note says something - do some homework. The numbers are either there or not. If trend following performance numbers did not exist for the many traders I have interviewed and or profiled, I never would have mentioned their names.

Brett Steenbarger Article

October 20, 2006

A good read (PDF) from Brett Steenbarger. An excerpt:

It is not at all unusual to find that a trader is losing with a trend following approach because he or she is acting out unmet personality needs in the market. One of the best trading strategies one can employ is to find adequate outlets for attention/affection, achievement, self-esteem, emotional well being, and excitement outside of trading. Sometimes traders I talk with try to impress me by explaining that trading is their entire life. They do not realize that their very 'passion' and 'obsession' with the markets are likely to sabotage them, imposing undue pressures and interference. If you have a trading system and you faithfully execute that system, trading should be reasonably boring and routine. Better to enjoy roller coasters outside of market hours than ride them with your equity curve!

Attacking Faith?

October 18, 2006

From Chris comes a head scratcher:

"I will be the first to give you a passing grade for putting a face on the trendfollowing methodology. And I follow your site with a great deal of respect for the body of work you produce. I just can't seem to understand why you seem to get so bent out shape when successful people credit God for their trading success or any success. If you don't believe in anything but your own greateness, well, I can respect that. But, for those of us who respect your work, and also have an abiding faith in God--please stop attacking our faith."

I did not know I was attacking Chris' faith. I do believe attributing trading success to "God" (whatever that means for whoever's religion) is illogical. Trading success, or any success for that matter, comes from hard work.

Another reader responded:

"Hi Michael-I feel I must come to your defense on this one. I guess I have followed your site for a year or so and to my way of thinking you have never attacked anyone's faith or lack thereof. I remember sending you my remembrances of my friend xxx and his comments on people who displayed Bibles or worse pictures of Jesus in their offices. If I had to bet ole' Chris probably has a big picture of Jesus in his office and I for one hope it helps him in his trading. In the Marine Corps we call folks like Chris REMF'S. If you are not familiar with the term I will send you the translation but I bet you know what it stands for!"

It is not my desire to have some big "faith" debate - to each his own. But when it comes to trading success...faith is not a reliable answer.

Commodity Only Fund

October 16, 2006

From the wires:

Oct. 16 (Bloomberg) -- Abraham Trading Co., a U.S.-based money manager with $140 million in assets, plans to raise $100 million for a commodity hedge fund. The so-called systematic fund, which started trading Oct. 1, relies on computers to decide when to buy and sell contracts in the energy, metals and agricultural markets, Shaun Jordon, director of marketing, said by phone from Austin, Texas, today. Abraham Trading, which was set up by Salem Abraham in 1988, also runs a managed futures fund which invests in 60 markets, more than half of which are commodities, Jordan said. Futures are contracts for delivery of a security at a specified time in the future at an agreed price. "As a result of client demand, we have decided to offer a fund that trades only the 34 commodity futures markets in our diversified program," Jordan said.

Wall Street Weaselwords

October 15, 2006

I do like Alan Sloan of Newsweek. He nails it here:

"There are times when having an English degree comes in handy for looking at the business world. This is one of those times, because the only way to grasp the essence of the Hewlett-Packard and "backdated" stock-options scandals is to speak in plain English instead of using euphemisms that obscure what's going on. As even non-English majors know, euphemisms—such as "advance to the rear" instead of "retreat"— are words designed to make ugly things sound less ugly. Think of it as putting perfume on a pig....Finally, we have the tried-and-true euphemisms that Wall Street uses to help keep money flowing into investments. When stock prices fall sharply, it's a "correction," not a "decline" or a "crash." If a drop is a correction, were the price rises preceding the drop a "mistake"? Of course not, they were a "rally." Then there's "profit taking." Which is really "selling," because no one knows if the sellers are taking gains or losses. I could go on, but you get the point. Euphemisms obscure. Plain English enlightens. So whenever anyone drops a market euphemism on you, tell her to stop prettying up pigs."

Dorsey, Wright & Associates, Inc. on Enron

October 13, 2006

A good white paper (PDF) from Dorsey, Wright & Associates, Inc. about Enron - price counts...

New White Paper

October 12, 2006

Here is a white paper (PDF) from Cambria Capital titled "A Quantitative Approach to Tactical Asset Allocation." Thanks to Mebane T. Faber for the contribution.

The Questionnaire

October 10, 2006

Feedback from an old pro trader from Commodities Corporation:

Hi Michael - A very good friend sent me a questionnaire over the weekend regarding a proposed upcoming "advanced" trading seminar he is putting together for down the road...As I have said before and I will say again while many methods work I have yet to see any one method work for EVERYONE...Anyway at the end of the questionnaire my friend asked for a brief discussion of what I personally thought every successful trader had mastered in becoming successful. To follow is my response in the order I believe of their importance:

In conclusion it is possible to start out risking 1% and end up losing 3% just as it must have been possible to start out risking 20% and end up losing over 60%. They are just numbers!

Good Advice

October 09, 2006

Jonathan Burton from MarketWatch had a recent article with some good bits of advice:

1. "There's more good investing information available and there are more qualified professionals giving advice than ever before, yet investors buy and sell impulsively, shoulder too much risk, or put off actions indefinitely. When they do invest, buyers often feel remorse if a decision goes against them in the short run. Sure, we wonder if an investment will do all right in the future, but perhaps more importantly we want to know that we took the right steps now."

3. "Find an approach that mirrors your way of thinking," said John Buckingham, editor of the Prudent Speculator, a top-performing stock newsletter. "Most investors end up not really following anybody's strategy and just cherry-picking ideas they get from variety of sources. What you need to do is stick with it, staying with the strategy. You need five years, if not 10, to prove a strategy works."

Searching for a Clue

October 08, 2006

Feedback received the other day:

"Greetings, what will happen with this? I put $100k into each of the top 8 fortune 100 companies and hold for 12 months. What's your prediction? What will it yield? Thanks."

I have no idea and nor does anyone else.

Who Won Amaranth's Losses?

An article forwarded in to me:

Arnold's hedge fund thrives as Amaranth falls
Centaurus gains approach 200% in '06, but manager has an enemy in Houston
By Alistair Barr, MarketWatch
Oct 5, 2006

SAN FRANCISCO (MarketWatch) - One man's trash is another man's treasure. When Amaranth Advisors LLC was losing $6 billion at the hands of its top natural gas trader Brian Hunter last month, rival energy hedge fund manager John Arnold was busy making millions.

Continue reading Who Won Amaranth's Losses? »

Feedback on Black Swans

October 07, 2006

Cole Wilcox of Blackstar Funds LLC added a comment on this post:

Some concepts that no one ever talks about, including the trend following managers themselves is that there is a very fundamental reason such strategies work. Every trade in every market is a risk transfer process. In the stock market, over the long term the risk transfer is almost always from seller to the buyer, in commodities it changes depending on the term structure because of the flip flop of premium or discount from front to back month contracts, which determines if you are getting a positive or negative risk premium or roll return. The buyers of risk in commodities, who can be either long or short depending on the current term structure require a risk premium to continue to participate over the long run. In commodities you have a risk transfer process from the hedger to risk taker or speculator. Hedgers are buying insurance, which requires them to pay for it. The price of this insurance is the "risk premium" which they must pay to the other side of the trade (speculators). On average trend following works because the trend follower is collecting the risk premium from the hedger because they are usually on the other side of the hedgers trade. My point is that insurance is not free, and this premium is a major factor to why trend followers have been successful in the past and in many cases should be expected to be successful in the future. I view trend following as an insurance business, who's job it is to collect risk premiums from hedgers and manage portfolio risk at the same time as to survive to continue to collect future risk premiums.

More on Boone Pickens

October 05, 2006

Boone Pickens uses fundamentals to make his decisions. He did tell me though, and I paraphrase, "It was hard to buy gas at $2 a gallon, but much easier to buy twice as much when it reached $3 a gallon."

I am envious of the 50 years of experience that Pickens has in the energy markets to make his decisions. He does, however, make that big money off of big trends. And 2005 saw energy trends out of this world.

Continue reading More on Boone Pickens »

Boone Pickens Interview

October 03, 2006

I mentioned the other day I was meeting with a trader in Dallas. Well, that 'trader' corrected me today during the interview. Boone Pickens prefers to be called an investor and doesn't consider himself a trader. To hear about his +600% for 2005 is simply inspiring. He is the rare man whipping Wall Street when many of his peers have retired. I don't get the impression Boone Pickens is slowing down - he seems to be picking up speed at 78.

Good Advice About Big Banks

October 02, 2006

Comments from Edward Talisse describing the inner workings of the large investment banks:

"There is massive confusion and misunderstanding between the concepts of skill and luck. Traders which collected bid-offer spreads for years discovered the painful truth once dealing spreads collapsed. They are left with no skill and no luck. Make sure you always study and keep ahead of the pack. Don't count on luck."

"There are very few real risk takers at the big Banks. The real emphasis is on collecting fees, collecting bid-offer spread where available and front running large client transactions. The real risk takers are purged at the first sign of trouble. The best ones go to Hedge Funds. Get out if you really believe you are a great risk taker. There are fewer constraints and bigger rewards outside the big Banks."

Texas Trader

I am in Dallas to conduct an interview with a very good trader. More to follow.