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

Price Movements Are Certain?

November 30, 2006

A comment sent in from an old pro trader today. It is a comment he sent to an associate that he thought my readers might enjoy:

"This morning as I do every morning I checked on the "opening call" in the Hog market. These calls are often accompanied by comments from brokerage house analysts and I found today's comments somewhat amusing. The comment was "price direction is uncertain due to the unknown direction of the cash market." While I am not an English major I would assume this comment on some levels infers there are times when the movement of cash prices are "certain"! As I always say I seem to learn something every day! I continue to believe the best way to make money is by simply "following" the trend no matter what time frame you choose to be involved in!"

Michael Mauboussin NPR Interview

November 29, 2006

An interesting audio interview with Michael Mauboussin on NPR Radio. You will need Real Player.

Hurricane Followup

I posted a comment the other day on hurricanes and prediction. One reader responded with a newsletter (PDF) from his firm put out in fall 2005. An excerpt:

As successful as the meteorological agencies have been in predicting the eventual scale of a cyclone, there is still a random element in this type of weather pattern. All the current early-warning models use a statistical distribution to model the hurricane characteristics and hence will always be vulnerable to statistical outliers. When this does occur, as in 2005, there is a tendency to seek explanations for these outliers from current events, for example global warming. People place too much faith in the predictive models used to forecast hurricanes and should rather be setup to react appropriately when these storms arrive.

Art Collins' New Book

November 28, 2006

Art Collins and Bob Pardo have written a new book titled "Beating the Financial Futures Market: Combining Small Biases into Powerful Money Making Strategies." In the essence of full disclosure, I do have a book jacket quote on the back of Art's book, so critics strike me down!

All trading books, including of course mine, can never be all things to all people. The trick is to find books that give a perspective that is not 'pie in the sky', but may actually bring forward multiple Aha Moments. Art is one of the few writers out there with the access to great traders able to pull this off. His multiple books are worth checking out.

Skip the Analysis and Go Straight to Price

Feedback received today:

Michael, I've been thinking recently about fundamental investors', and really most of Wall Street's rejection of trends in stock prices, and that bucking the trend is really the ticket to success. They may convince themselves of this fallacy, but in reality, anyone who is successful in the financial markets is a trend follower, even fundamental investors...There are certainly people who jump the gun and purchase an equity when they think it is "cheap" while everybody else thinks it's "expensive." But as time goes on, the sentiment regarding an investment opportunity that is decreasing in price will grow more positive and people will begin to purchase the equity. So fundamental investing really does not ignore trends. In fact, in order for fundamental investors to make money, they have to ride trends of market sentiment toward profitability. However, these fundamental investors are at a significant disadvantage to trend followers because while both essentially follow market sentiment (fundamental investors through financial statements, common knowledge, etc. and trend followers through price), trend followers have the added benefit of utilizing calculated risk so that a bad winning percentage, or better yet a bad trade, does not eat them alive. It also doesn't hurt that price is a much more concrete and certain measurement than an amalgamation of all those subjective fundamental measurements.

Joe makes a good point. Fundamental traders, no matter how they arrive at their analysis and whether it is valid or not, still have to have at the end of the day "a trend" to profit. Without trend (unless you are a leveraged hedge fund selling options and we know how that often ends) you will have a mighty hard time finding profit over the course of a lifetime. The larger point in the comment above is that instead of trying to assemble all of the analysis that purports to tell you what price is doing, why not just go straight to the horse's mouth and follow price from the beginning.

Hurricane Predictions Fall Short

November 27, 2006

From the Tampa Tribune:

With cataclysmic predictions that hurricanes would swarm from the tropics like termites, no one thought 2006 would be the most tranquil season in a decade. Barring a last-second surprise from the tropics, the season will end Thursday with nine named storms, and only five of those hurricanes. This year is the first season since 1997 that only one storm nudged its way into the Gulf of Mexico. So what happened? Lots. Storms were starved for fuel after ingesting masses of dry Saharan dust and air over the Atlantic Ocean. Scientists say the storm-snuffing dust was more abundant than usual this year. In the season's peak, storms were curving right like errant field goals. High pressure that normally hunkers near Bermuda shifted far eastward, and five storms rode the clockwise winds away from Florida. As they say about the stock market: Past results are no indication of future performance.

Study: Money-Happiness Link Is Complex

November 26, 2006

Food for thought:

NEW YORK -- (AP) Does money buy happiness? The connection is complex, he says. But in fact, very rich people rate substantially higher in satisfaction with life than very poor people do, even within wealthy nations, he says. "There is overwhelming evidence that money buys happiness," said economist Andrew Oswald of the University of Warwick in England. The main debate, he said, is how strong the effect is.

Continue reading Study: Money-Happiness Link Is Complex »

Not Much Change at the Big Brokers

Feedback:

Michael, thank you for writing Trend Following! I read your book while I was interning on a sales & trading desk (sadly it wasn't required reading). Until I read Trend Following, I was always baffled by how analysts came to conclusions and how fundamentals were weighted and valued. Intuitively, I thought it rather absurd that the majority of analyst recommendations were BUY and that all SELL recommendations tended to come around the same time. I'm only 22 years old, but my goal is to learn as much as I can about trend following, practice it, hone my system, and eventually become a successful trend follower. Your website has been more helpful than my $200 college text books. Thanks!

While I appreciate the nice words, this email is really useful as a reminder about how little Wall Street has changed since the Dot Com Bomb 6 years ago. Here is a young guy making his way into the field and all he sees are people making predictions. And the only reason that the predictions never stop? The end user, the doctor, the attorney, the 'get rich quick guy' demands predictions. They love them! Human nature never changes!

Put Into "Code" Means What?

November 24, 2006

Feedback:

Hey Michael, Hello, I am a mathematics and philosophy student at Michigan Tech University. I loved reading your book twice; I am going to read it a third time. I find the trend trading philosophy to be very stoic and the concept, rather simple yet eye-opening. Often I find myself teaching others about your style of trading and even debating with others about indicators (basically all indicators never stack up to price in the long run or any run for that matter)...When you say "turn your philosophies into computer code" what exactly do you mean by this. If I am more of a risk taker, make bigger bets that sort of deal?

Real straightforward. If your rule, for example, is to buy when a market makes a 100 day high - then make that a rule you can put into computer code. That's it. Of course that can expand out to cover much more than my simple example.

Mental Levels

November 23, 2006

Feedback from an old pro trader:

After over 30 years of being involved in the futures markets I have now come to the conclusion that the old cliche about trading being 90% mental is really true. As I have stated before Trend Following may not be everyone's cup of tea either because of emotional or perhaps financial issues, but I can guarantee you one thing-trading AGAINST the trend in any time frame will lead to a very short and painful trading career be it hourly or weekly. I have been listening to some of my old "mental" tapes and here are the "Mental Levels" of trading successfully.

Unconscious Competence: Where I am now I don't even think about "it" I just do "it"! There are no parts of my brain screaming, "Is this really a set up?" or "What if this does not work?” I have found myself in the "flow" and have accepted that losing trades simply put me closer to winning trades. I have also become more humble realizing what I had to go through to get "here" and the funny thing is that I truly feel I have only scratched the surface of what I have yet to know! Have a great trip to the Far East!

Mean Reversion on YouTube.com

November 21, 2006

I added a new video excerpt to YouTube.com today. The other (3) clips can be found here.

Citadel: Rumors Unfounded

From yesterday:

Rumor has it that another major hedge fund in the U.S. is headed for a meltdown and reportedly may be behind the recent drop in the U.S. dollar as it allegedly diverted capital to cover losses in energy trades. Chicago-based Citadel Investment Group has denied that it is the hedge fund in trouble, telling The Wall Street Journal that the rumors concerning it are unfounded.

More from the Wall Street Journal:

Citadel Investment Group LLC, the $12 billion Chicago hedge fund, says it continues to enjoy a successful year and isn’t suffering from big energy bets gone bad — despite speculation coursing through financial markets today that the firm is dealing with heavy losses. “We are aware of the rumors. They are completely unfounded,” says Bryan Locke, a spokesman for Citadel. Mr. Locke wouldn’t give details about the firm’s performance this year. However, an investor in Citadel said the firm remains up about 20% so far this year, despite sharp price declines in the energy markets in recent days. Citadel’s returns are better than major stock market measures this year. In early September, Citadel, which does everything from market making in options to energy trading, teamed up with J.P. Morgan Chase & Co. to purchase the energy portfolio of struggling Amaranth Advisors.

Feedback on the "+20%":

It means nothing when they say 'we're still up 20%'. Amaranth was 'up 30%' in one week, and 'down 60%' the next. When funds play with highly concentrated leveraged bets, things can go sour real quick.

The California Garbage Collectors Union

Feedback from an earlier post:

Michael Covel, Wake up! Our government put Al Capone out of business and took over his business. It's called the protection racket! As a previous member of the CME I experienced this first hand. The head of the newly formed CFTC was a guest speaker at our annual members meeting. His speech was real short and real direct. I'll never forget it. He said, "The California Garbage Collectors Union" has a lobbyist in Washington D.C. and you guys aren't even in the directory and you had better get someone up there to watch your back! Less than 90 days later a bill was intro ducted in the house that if passed, would put the futures industry out of business in the U.S. Guess what! Magically a PAC was formed and money was sent to D.C.! O'yes, the "Shake Down" is what they really do and that's pretty much it, period! It's an art form with these guys. Don't forget, most of them are attorneys. Gary C.

Ann Taylor Stores (ANN)

November 20, 2006

Feedback:

Hello, Michael! Maybe some of your more fundamentally oriented contacts would like the opportunity to explain this: Last Friday, before the market opened, Ann Taylor Stores (ANN) announced that quarterly earnings had beaten the year-earlier by 29%. Sounds to me like a good fundamental story. This was above the analyst consensus expectation, which is usually good for a gap up. Yet, on Friday, almost 8% of ANN’s market capitalization was wiped out because management made a remark that the coming year was expected to be flat. News organizations reported that investors were “disappointed” by this remark and that explained the drop. Are management comments “fundamental”? Are they more fundamental than the hard numbers? It seems to me that fundamental traders who are in love with a stock can always find some justification for buying it, and if a fundamental trader wants to dump it, he can find a fundamental story somewhere to justify the sell order. Thank you for letting me rant. Regards, Chuck

Just the First 50 Seconds

November 19, 2006

I don't know the man in the video clip that follows. I just want my readers to consider the first 50 seconds of this video. His style or how he trades is not something I subscribe to or track, but his opening 50 seconds where he talks about the difficulties of speaking about 'performance' is useful. The rest of his pitch is a rambling fundamental monologue not useful in my opinion.

Where's the Beef?

Consider this excerpt from Marketwatch.com:

Paul Mendelsohn, chief investment strategist at Windham Financial Services, said this week's tamer-than-expected inflation data was another support for equities, which finished higher for the week...Mendelsohn said the Thanksgiving break may give market players time to assess the run-up in stocks. "The market is incredibly overbought. In addition, bullish sentiment has really skyrocketed which would be another warning signal. I'm participating in this rally, but...my antenna is up," he said.

How does one go about assessing a run up in stocks? What does overbought mean in concrete terms, not just jargon speak? Bullish sentiment (which is exactly what?) would be a warning signal to what? Is there some kind of rulebook that defines when these warning signals happen and what you should do?

What Trading Teaches Us About Life

'What Trading Teaches Us About Life' is a good top 10 list from Brett N. Steenbarger, Ph.D.

Trading is a crucible of life: it distills, in a matter of minutes, the basic human challenge: the need to judge, plan, and seek values under conditions of risk and uncertainty. In mastering trading, we necessarily face and master ourselves. Very few arenas of life so immediately reward self-development--and punish its absence. So many life lessons can be culled from trading and the markets:

10) A formula for success in life and finance: never hold an investment that you would not be willing to purchase afresh today.

Cocktail Banter

November 17, 2006

Feedback from last night about this podcast:

Michael, That cocktail quote is bang on. I was involved, as a partner, in a management company, which oversaw the commercial hedging side of a large group of hog producers (over 700,000 hogs per year in various weight stages). Our futures positions were initiated and exited based on a set of rigid criteria which included the bottom-line profit available (position placement) and hog/feed delivery (position removal). We basically applied a 'hog crush' to the operations production; the more profit, the further out we went. We had to deal with all of the common fundamental questions of where we saw the market going etc. etc. We became a broken record constantly repeating "When we get this much profit we put this many positions on ..." At some point the person's eyes would glaze over and the conversation would dry up. I think it's just human nature for people to want the fundamentals. It gives them a sense of accomplishment -- however false. Regards, Cliff G.

Jim Cramer on Hedge Funds

November 16, 2006

Jim Cramer offers some good and bad comments about hedge funds here. His conclusion:

In the end, the lesson to be learned from Amaranth isn't about a sole runaway manager who made bad bets on the weather. It's about broad institutional problems: how hedge funds are run and monitored, and who's investing in them. Hedge-fund strategies have become so obtuse, their sales pitches so aggressive, and their monitoring so lax that one could question whether anyone should be in these funds, let alone pension-plan managers who have no ability to judge what these funds are doing and are supposed to invest regular folks-money in relatively safe places. Sure, pension funds that opt out won't generate the huge returns that hedge funds do in good times, but more important, they won't get crushed in the bad ones. The simple truth is that only the rich, who can take the hit, belong in these funds. And even they should proceed with extreme caution.

As I commented recently on Christopher Cox's similar views, what about mutual funds? They can't go down? To keep lumping all hedge fund strategies into the same camp is not an accurate portrayal of reality. Cramer is dead wrong when he implies the average guy should have no access to something beyond buy and hold long only. Of course, you need to be careful and do your homework, but that's the case for just about everything in life these days.

The Shakedown!

November 14, 2006

Feedback below from my earlier post:

Hi Mike, I agree that there is a hidden story i.e. it could be the mutual funds spending a lot of money on lobbying to protect their turf. I think what is more likely is that the politicians are waking up to how much money is being made by HF managers. So they threaten to regulate them, and in return HFs are then forced to start spending money on lobbyists as well. If you look at the amount of money that HFs are giving to political candidates, it has skyrocketed in the past few years. I don't think it is a coincidence that politicians started focusing on increasing regulations for HFs only in the past few years. This is a classic shakedown of a growing and prosperous industry by government. Best, XXX

Up in Smoke

November 13, 2006

From Ben Stein:

I'm 61, and have many friends who are roughly the same age. In fact, most of my friends range in age from 50 to around 65. Some of them are far happier and more self-confident than others. Some of them have plans to go places, play golf, take photos of exotic lands. That's some of them. The others are in fear, afraid to leave their houses, afraid to think of growing old -- just plain afraid. I can think of two major differences between the ones who are successful and the ones who are not. The first difference is that the confident group did not disable themselves by drug use or excessive alcohol use. It's an amazing thing, but it's true: The men and women I know who have spent a lot of time smoking pot have, by and large, thrown their lives away in the pursuit of feeling no pain. There are exceptions, but typically they can barely get out of bed, let alone pursue a career aggressively or save in a disciplined way. Basic, long-term sobriety seems to me a precondition for a successful life, and certainly a precondition -- in most cases -- for a life of prudence as far as money is concerned. The man or woman lost in marijuana-induced bliss cannot and will not be able to evaluate investment options and pick the best ones -- it's that simple. One of the many blessings of sobriety is to be able to invest sensibly.

Asia Interview Requests

I will be in Tokyo and Hong Kong in December. If you are with a hedge fund and or investment bank and would like to speak in person either on or off the record for a new book I am working on, drop me an email in the next 2 weeks. I am specifically looking for non-US perspectives.

More Regulations on Hedge Funds from Christopher Cox

November 12, 2006

Take a quick read of Christopher Cox' Testimony Concerning the Regulation of Hedge Funds. Now consider excerpts from Bloomberg News on November 11, 2006:

NEW YORK -- The Securities and Exchange Commission will propose rules next month raising asset requirements for investing in hedge funds after Amaranth Advisors LLC lost $6.5 billion on bad natural gas trades...Senate Finance Committee Chairman Charles Grassley has asked Cox and Treasury Secretary Henry Paulson to figure out ways to boost transparency in the $1.3 trillion hedge-fund industry, which is largely unregulated. Grassley said in a letter Oct. 16 that "hedge-fund investments could put the retirement security of American workers in jeopardy."

Let me get this straight. Amaranth blows up so we need new laws? I am for transparency, but how about some transparency for the true intentions of politicians too? Grassley is worried about pension fund money in hedge funds, but not pension fund money in mutual funds? What those can't go down? Of course they can go down and do (i.e. dot com bubble)!

My gut tells me there is a story behind the story here. How much lobbying money is being pushed into Congress from big mutual fund firms seeking to protect their monopoly on keeping retirement assets locked up in 'long only' investing strategies? I bet it is a huge dollar figure. The government's effort to keep the average Joe away from alternate investing strategies is not so noble in my opinion.

"Make Money Every Month!"

November 11, 2006

Feedback in today:

Hi. I very much enjoyed reading Trend Following. I'm currently trying to learn more about trading and aim to build an expertise in it. In the meantime, I have a question for you. Based on your gut/common sense / experience does the following trader sound legitimate to you? There is a trader who is via an "investment club" offering/giving monthly returns of around 7-11% to investors. He is trading foreign currencies (beyond that I don't have more information). Investors get statements, however there is no other information shared with them on the accounts/financials of the operation. The operation is registered offshore in Panama (he was doing his trading from Jamaica, and I understand he is now living / working from the US. He recently bought a plane I hear). He seems to have opened up the 'investment club' in the last 2 or so years. As far as I know he is subject to no regulator (or rather has not subjected his operations to any, i.e. the 'investment club' and offshore arrangement were designed to avoid regulators). I find the steady consistent monthly returns a red flag (seems like a guaranteed return that is unlikely given the fluctuations a trading profit). Am I being arrogant/too cynical. In other words -based on the brief sketch I have given you - do you think this guy's returns are legit? Regards, Monique

Christopher Cox might want to shine his flashlight here instead of making reputable hedge funds jump through more inane hoops.

SEC Chairman Christopher Cox Needs to Go

November 10, 2006

Today across the wires:

Nov. 10 (Bloomberg) -- U.S. Securities and Exchange Commission Chairman Christopher Cox said the agency will propose rules next month making it harder to invest in hedge funds. "We're going to make it very clear that hedge funds are risky investments that are not for mom and pop by fencing it off with higher standards to accrediting investors," Cox said in an interview today.

This is an idiotic statement. So there is now one definition of "risk" applicable to all types of hedge funds? What is it?

I would like to know if Mr. Cox thinks being down over 50% for six years buying and holding the NASDAQ was risky? How in the world did a bunch of politicians come to think they know what is right for people's portfolios?

Political Shift Doesn't Remove Your Responsibility

November 08, 2006

Some people seem to be excited that a change in politics will benefit their portfolios. I say nonsense. Regardless of who is in power in DC you need a plan that tells you what to do every day with your portfolio. If you are excited that you will make more money with a new Speaker of the House or if you believe you would have made more money with the old Speaker of the House - I say both of you would be off.

In my opinion articles like this (PDF) are much more important to your chances of getting rich than placing your hopes on the back of politicians.

Passionate Criticism

November 06, 2006

The book Trend Following brings forward the passion. Here is a review seen recently:

After reading 100 pages I still have yet to see a definition of trend following. Tries to add props by invoking great trend followers. This book really pissed me off, website is the same, lauds trend following, rips everything else. What the F**K is it?

I can't tell whether reviews like this are serious (i.e. not just competitive business reviews) or whether the reader really doesn't "see" it. I do know from literally thousands of reader emails, that the book does answer this question for many. That said, I wish it answered it for all!

Don't Stare at the Screen All Day (Video Excerpt)

November 05, 2006

3rd video clip from September presentation in Hong Kong.

Pictures of event below.

Mark Shore White Paper on Skew

November 03, 2006

I had the opportunity to meet Mark Shore last spring in New York City at a presentation. His paper on 'Skew' (PDF) will be of interest to many readers.

Sabermetrician Bill James on Objectivity

November 02, 2006

I was forwarded this excerpt, which apparently first appeared on Victor Niederhoffer's site from a contributor. It is Sabermetrician Bill James speaking, from his 1981 Baseball Abstract, on the difference between sports writing and sabermetrics:

1. Sports writing draws on the available evidence, and forces conclusions by selecting and arranging that evidence so that it points in the direction desired. Sabermetrics introduces new evidence, previously unknown data derived from original source material.

3. Sportswriters characteristically begin their analysis with a position on an issue; sabermetrics begins with the issue itself. The most over-used form in journalism is the diatribe, the endless impassioned and quasi-logical pitches for the cause of the day--Mike Norris for the Cy Young Award, Rickey Henderson for MVP, Gil Hodges for the Hall of Fame, everybody for lower salaries and let's all line up against the DH. Sports writing "analysis" is largely an adversary process, with the most successful sportswriter being the one who is the most effective advocate of his position. I personally, of course, have positions which I advocate occasionally, but sabermetrics by its nature is unemotional, non-committal. The sportswriter attempts to be a good lawyer; the sabermetrician, a fair judge.

James objective decision making process dovetails nicely with the objective decision making of his current boss trend following trader John W. Henry.