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

Can You Accept A World of Probabilities?

January 31, 2007

Michael, As I suspect is the case of most of your informed readers, I've been enjoying tremendously the illogical ramblings you've been posting lately on your blog (e.g. Looking for a Trend, Much Ado About Nothing, etc.). It is amazing how many people just don't "get it". They seem to have great difficulty accepting a key concept: Trying to predict the future is impossible because of the complexity of the environment. The conventional deterministic logic that allowed the human race to survive in pre-history (i.e. finding a "reason" that explains how things happen) doesn't work when analyzing complex systems. I studied physics in college, and I remember that once we went from the Newtonian deterministic world to that of Quantum Mechanics (which only gives you PROBABILITIES of particles being in a certain location of space/time) everyone had a difficult time grasping the concept (myself included). As numerous studies have shown, our brain isn't "wired" to think in terms of probabilities, conceivably due to how our ancestors evolved millions of years ago - which I think is all to the good! If the majority of people understood probabilities and the limits of deterministic thinking (unlike the sloppy thinkers that you've posted), we might not be able to make money in the market using relatively straight forward trend following strategies. So all I can say is hooray for all the "Cave Men" out there!! Best regards, A. A.

Feedback on "Rain"

Some great feedback on a post that mentioned 'rain' the other day:

Michael - The emailer who ridiculed the idea of betting on "rain" or "no rain"? I'd be happy to take those trades if I knew that a correct bet paid off 2-to-1, or 3-to-1, and an incorrect bet paid off 1-to-1! That's what critics don't ever seem to get about trend-following. Its not about being "right" or "wrong" - its about the expectation of the payoff when you win. I try to explain it this way to friends and colleagues (who never seem to get it either). Granted this is a generalized method that doesn't include trading costs, etc, but I think it makes the point. I'm going to make 10 trades. Before each trade, I'll identify a place on the chart where I will exit the trade for a loss of 1-percent of my total portfolio value if I'm wrong. Let's suppose I make 7 bad trades out of 10. A little math: 7 x (-1%) = a loss of 7% to my portfolio. If I make even a tiny gain on each of the other 3 trades, let's say 5% ( 3 x +5% = gain of 15%), then I've just made 8% (gain of 15% minus loss of 7%) after 10 trades, even though I was wrong a majority of the time. Simple enough. What's the hard part? The hard part is admitting you were wrong on the 7 trades, and exiting when you said you would. In my opinion (and experience), a person can use whatever entry/exit method he/she wants - 55-day breakouts, MACD, stochastics, the moon moving into the house of Aquarius... You want to pick a bottom or a top because of a certain jiggle on the chart? Go ahead - as long as you're only going to lose a fraction of your portfolio if you're wrong. Once you embrace the idea of not getting hung up on predicting a market's behavior, you are suddenly "freed from tyranny." You no longer stay up until 4am analyzing charts and looking for the "holy grail" indicator. You no longer hem and haw over whether to buy or sell a promising stock, only to watch it go up (or down) a little each day until you feel like you've "missed the move" and have even more regret. It becomes easier to shut it all off at the end of the day. In short, you have a life. And best of all, you gain confidence, and over time, make money.

Looking for a Trend...

January 30, 2007

Feedback in from a reader:

What I am unwilling to do is to take something as a truism just because someone says that is the case. Of course, your counter would be "Look at the results of the "Great Traders" cited in your book; however, I could point out that the same rationale could be taken with, say, golf; look at Tiger Woods, or Ben Hogan or Sam Snead - and my response is that the exception doesn't prove the rule - there are some standouts in any endeavor, and that doesn't mean that the "common man" is going to be successful just because there examples of golfers following a certain methodology. I also can comprehend the concept of trading a trend, together with the prerequisites of money and risk management. Obviously, the later two points - money and risk management - are not necessarily unique to a trend following system. Nor for that matter need the systematic approach be unique. Where I have yet to read in your writings, both the book and your web site, is the "how" of finding trends to follow. Without fundamental research, it would seem haphazard to just choose a stock, or commodity, or whatever instrument, and hopping for the best that a person has picked the right vehicle. As Mr. Seykota has pointed out, any trend is a measure of the past, and there is no such thing as the future. I don't buy that, but that is what his view is. What does seem likely, is that the so called "great traders” have through trial and error, experience, or gut feel, or intuition, developed a "feel" for the markets they are trading day in and day out, and are thus able to at least identify the most likely candidates to pursue. BUT, that ability has come with experience and knowledge of the markets they choose to trade; I would equate that with fundamental research. You call it what you will. Of course, an approach would be to "shotgun" the situation by diversifying to the point that one has covered all, or a significant number of, markets so that some are bound to go up if one is going long, or down in price if one is looking to go short. That doesn't necessarily prove the efficacy of the system; it does prove that "chance" can prove you right given enough opportunities. The larger traders with higher capital can afford to spread their bets since they have greater capital amounts. The smaller capitalized trader either would have to significantly reduce the number of markets traded and/or place very small bets in a number of markets. It would seem that if any of the above is a reasonable analysis, then a very important part of trend following is diversification. And in so doing, chances are that at least one or more of the chosen markets are going to trend in the direction you hope for. If you can point me in the direction of any literature or whatever on the "how" and mechanics of how to find a market to follow the trend, I should be most appreciative. I apologize for the length of this. Thanks very much.

p. 227 of Trend Following goes right to your desire to pinpoint a trend. I agree with Seykota.

No Rain

January 29, 2007

This post brought in this feedback:

IMHO, the author must be confused about trend following (and a technical approach to trading). If one were to create a model or system based upon observances of "rain" or "sunshine" (one type of "non-rain") that would be a technical system, not a fundamental one. Making predictions is for people who like the feelings around appearing intelligent or being "correct", which has nothing to do with being a profitable trader. If anything, it is emotional intelligence that matters most in trading. Also to consider that as a speculator, sometimes you don't have to make any predictions or decisions about "the rest of the day" - you can just observe the weather and enjoy that, unless you like the feeling of making predictions. My guess is that your new fan likes those feelings.

Religious Fervor Is Not Wise For Your Portfolio

January 28, 2007

This email came into tonight:

Hi there, I live in London and I want to buy shares on the London Stock Exchange, but I don't know which shares to buy which are XXX principle compliant. Please guide me to where I can find out about this OR any group who is already buying shares according to XXX principles. Kind regards, XXX

This is the first email I have ever received like this. After 10 years and tens of thousands of emails, I hope this 'thinking' is not the start of a trend. To think like the above email in my humble opinion - is wacky. Beyond wacky, the markets are hard enough without tying one arm behind your back.

Hedge Funds and Politics

January 26, 2007

From the New York Times (link):

"Money from Wall Street has long been a factor in Washington and has tended to flow, with a policy agenda, to the ascendant political party. Giving by people in hedge funds, on the other hand, tends to be more personal and ideological. Some of the most aggressive donors have been Democratic supporters like George Soros, David E. Shaw of D. E. Shaw and James H. Simons at Renaissance Technologies, as well as younger executives like Thomas F. Steyer at Farallon and Marc Lasry at Avenue Capital, all of whom gave generously during the 2006 election cycle. While hedge fund money appears to be tilting toward Democrats of late, Republican donors like Julian H. Robertson Jr., the founder of Tiger Management, who has given more than $700,000 over the last three cycles, and Bruce Kovner at Caxton Associates have backed their party’s candidates and causes. Still, compared with the billions of dollars that hedge fund magnates have spent on art, mansions and other extravagances, these political donations are a pittance, held in check by federal finance laws that limit personal contributions to $2,100 and by a general reluctance to step into the public limelight. But with the rapid growth of their money and stature, an increasing number of the hedge fund wealthy are not just putting their money to work, they are forging personal and professional ties with a generation of politicians who have come to spend as much time raising money as they do drafting legislation.

Michael Mauboussin on Diverse Thinking

January 24, 2007

Michael Mauboussin, Chief Investment Strategist of Legg Mason Capital Management (LMCM), is just an interesting thinker. His latest effort (PDF).

Does Everyone Win?

January 23, 2007

Feedback:

Biggest pet peeve - whatever chucklehead on TV saying stocks went down due to "profit taking." EVERY TIME, like clockwork, people are profit taking, which takes the market down. Where are all these profitable traders? Does anyone ever take a loss? Ridiculous.

What Does This Mean Exactly?

I don't say this to take any particular political stance, but Jim Webb (rebutting the Presidential State of the Union) said tonight that the increased profits of US corporations need to be "shared" more with everyone. On the face of it, Democrat or Republican, that type of talk is scary. What does it mean exactly? And my comment is not an endorsement of anyone tonight or any other issue. My perspective is simply a Seinfeld-esque reflection on that one comment about "sharing".

Yahoo Inc. Makes Some News...

Take a look at the last year chart of Yahoo. Now consider an AP news story about Yahoo today:

Yahoo Inc.'s fourth-quarter profit topped analysts' expectations to end a recent pattern of financial letdowns, a breakthrough that the Internet bellwether hopes to build upon by accelerating the introduction of long-awaited improvements to the advertising system that fuels its growth. The pleasant surprise lifted Yahoo's stock price by more than 5 percent late Tuesday after management shared the news. The Sunnyvale-based company said it earned $268.7 million, or 19 cents per share, during the final three months of 2006, traditionally the peak season for Web sites like Yahoo that depend on advertising for most of their revenue. The profit declined 61 percent from net income of $683.2 million, or 46 cents per share, at the same time in 2005, but the two quarters didn't provide an apples-to-apples comparison. That's because a one-time gain of $310 million boosted the 2005 results while the 2006 figures included stock option expenses that weren't recorded on Yahoo's books in the previous year. If not for certain tax benefits, Yahoo said it would have earned 16 cents per share, exceeding the average analysts' estimate by 3 cents per share, according to Thomson Financial.

Given the 1 year chart and given today's news...where does it seem logical that 'long' Yahoo makes sense? Isn't there a disconnect between the chart movement and the "news" of today?

Feedback on Anger

January 22, 2007

Michael, concerning the "Anger on Top of Anger", it's a shame that this trader criticizes trend following without giving his suggestions on what makes a profitable trading system. I'd like to know his definition of a "top trader" or a "top hedge fund". It's quiet possible that he thought Brian Hunter was a top trader, or Amaranth was a top hedge fund. Anyways, I suppose in his mind it is better to be on "top" and blow up, than be in the middle and have long term profitability.

I still want to know if the angry guy in question feels as if his hedge fund is lucky too?

Tough Luck in the Rough

From a WSJ 'golf' article comes an excerpt about the long run:

So how should golfers treat luck, both good and bad, when it happens to them? Don't be paranoid or solipsistic. Gio Valiante, a mental-game consultant and author, says golfers "must separate what is controllable and what is not controllable." Weather and bounces, both good and bad, are definitely not. Dr. Valiante, who wrote the book "Fearless Golf," said golfers must "expect the best, but prepare for everything." When it seems that all the bounces are going your opponent's way, remind yourself that golf is a "fair game" and over many rounds of golf, the bounces do even out. For what most of us call luck, Dr. Valiante uses the more mathematical neutral term of probability. In other words, the golf gods aren't always against you. Really. But this time, pay up, pal.

Anger On Top of Anger

January 21, 2007

Some recent feedback:

But you are out of your league here, Covel. I've got an office full of traders, for one of the top hedge funds in the country, laughing at you over here on their coffee break because you are so out of your league in this discussion on statistics. Our CEO and founder agrees with us, and you have his name on your website. I'd be careful to publicly disagree and post your [incorrect] opinions on your blog until you are certain you are correct about something...Statistically, it is a certainty i am right -- that there is no proof these surviving trend following managers are not just black swans who dodged bullets well enough to stay alive.

That is feedback from a man who subscribes to the million monkey theorem. His view? All trend following traders with success are simply lucky. I asked if that applied to everything in life? Microsoft, Google, etc. I asked if that applied to other styles of trading beyond trend following? I asked if it applied to his firm (which I don't know the name of)? He did not answer.

We Can Spot Snakes In The Grass Faster Than Harmless Objects

January 20, 2007

The American Psychological Association put out a press release:

Swedish Studies Show That We Can Spot Snakes In The Grass Faster Than Harmless Objects

WASHINGTON - It's long been thought that the common phobias of snakes and spiders are reminders of homo sapiens' primal past. Now new studies suggest that human perception evolved to accurately and efficiently spot these environmental threats. The research appears in the September issue of the Journal of Experimental Psychology: General, published by the American Psychological Association (APA).

Continue reading We Can Spot Snakes In The Grass Faster Than Harmless Objects »

Bite & Spit

January 18, 2007

This excerpt regarding shark attacks paints a useful picture for traders and entrepreneurs alike:

Bite & Spit: These attacks are characterized by a forceful initial strike, often lifting the prey and shark clean out of the water. The prey is then released and the shark moves away, leaving the animal to bleed to death. This was considered to allow the prey to die whilst preventing injury to the shark from a wounded animal. This method of attack...was based on bite wounds observed on surviving pinnipeds and accounts of White sharks leaving the prey after an initial incapacitating attack.

A Plan for Silver!

Logic, reason, discipline - forget it. I just read this and my entire world view shifted instantly:

Hi! I'm Jason Hommel. Let me tell you how you can make money, by investing in silver and silver stocks! I'll tell you why silver prices must keep going up (probably far higher than $25-$50/oz.) due to the shortage of silver! Many silver stocks can rise 5 to 10 times as fast as silver! Many natural resource stocks have already risen by 1000% and more, and other stocks can do that too! How will you know which silver stocks to buy? Get on my email list!

Are You "Short" Energy?

There are literally millions of plausible reasons why energy has been dropping in price. Does it really matter why? When you look at the charts of Crude Oil, Natural Gas and Heating Oil - why would it matter why these markets have gone straight down as long as you were short and able to profit?

Oil Trends or Oil Fundamentals?

January 16, 2007

Feedback in tonight:

Michael, one of the sectors i follow over at our hedge fund ... is the energy sector. Wanted to mention some observations that I have. Now that you pointed out to me to observe trends in all aspects of life, I have done so, and sort of clarified a few things.

Trend 3: Oil and nat gas prices. both are heading down and are dumbfounding the "experts". Economics 101 tells you that the price of a good or service (or commodity) will head to the marginal cost of supply, which in the case of oil, is about $42/barrel. No one mentions this on CNBC or any of the other talking heads stations. and, because of so many mutual funds, pension funds and hedge funds, have made their numbers on the energy stocks. Amaranth and Mother Rock will not be the only cucarachas to see the light of day. We'll certainly will have another fund(s) blow up and probably a big pension fund or money mgr have huge down ticks in performance as a result.

I see your view, but from a trend following perspective, a follow the price perspective, I would argue that you are providing elaborate fundamental views. You COULD just make your decisions off price movement alone...and forget the fundamental analysis and predictions.

Cambridge Appoints Professor of Risk; David Harding Effort

January 15, 2007

An interesting press release:

David Harding

A new Professorship designed to help improve people’s understanding of the mathematics of risk is being established at the University of Cambridge.

The new Winton Professor of the Public Understanding of Risk will seek to help individuals, institutions and government refine their decisions in risky situations.

Risk is a factor in all human activity and different people react to risks in very different ways. Questions requiring a scientific ability to assess the chances of something happening – or not happening – arise all the time. Here are some examples:

• Following the poisoning of the Russian ex-spy Alexander Litvinenko, traces of polonium-210 were found at various locations in London that he had visited. Statistically, how probable is it that someone who visited the same locations at a later stage would contract radiation poisoning?

• A recent study of transfusion patients given blood contaminated with the human form of mad cow disease has indicated that the 24 still alive are at “substantial” risk of contracting vCJD. What are the risks of contracting vCJD via a blood transfusion? How do they compare to the risks of getting the same condition by eating meat?

• An apparently healthy woman is judged to be at risk of breast cancer and is advised to undergo mastectomy. Should she do so?

• A person has to cross a main road to reach the shops. Should (s)he walk straight across the road, or use an available footbridge instead?

• How sensible would it be for me to invest in the stock market today? Might delaying improve my prospects greatly?

• A 29-year-old man decides to marry his girlfriend of three years. What is the chance that he will meet a more suitable partner at a later stage?

As these examples show, risks need to be considered in both the most ordinary of situations, and in high-pressure environments. Risk assessment is often based on analysis of data, but there is always a danger that statistics can be abused. Expert evidence in courts has been subjected to close scrutiny in recent high-profile cases such as the prosecution in the USA of OJ Simpson, and the cases of SIDS (sudden infant death syndrome) in the UK.

“The way to confront risk is via mathematics and statistics,” Professor Geoffrey Grimmett, head of the Department of Pure Mathematics and Mathematical Statistics, said. “This new Professorship will enable Cambridge to play an important role in clarifying the understanding of risk in many fields of human endeavour. It will strengthen our ability to reach out beyond Cambridge to government and the public alike.”

The new Winton Professorship has been created in perpetuity in the Statistical Laboratory of Cambridge University, thanks to a £3.3 million donation from The Winton Charitable Foundation. David Harding, a Cambridge alumnus and Managing Director of Winton Capital Management, a London-based hedge fund, is a Trustee of the Foundation.

“My time at Cambridge studying Natural Sciences showed me the importance of accuracy in empirical information and its interpretation,” he said. “This has been a key factor in my career in finance and is highly relevant to our awareness of the risks that affect us in our everyday lives. I am delighted to make a contribution to public debate and policy by helping create this new position at Cambridge.”

Professor Alison Richard, Vice-Chancellor of the University of Cambridge, said: “The Winton Charitable Foundation has been wonderfully generous in its support of the Cambridge 800th Anniversary Campaign. Endowed positions such as the Winton Professorship are of very special value to the University and I look forward to appointing the inaugural holder of this major new post.”

Feedback on Ken Tropin

Feedback from a reader about trend follower Ken Tropin (Graham Capital):

I have great respect for Ken Tropin who from my standpoint runs his business using same the philosophies he manages his trades. He takes a small percentage risk on traders and their strategies, cuts his losers, and piles into his winners - trend following techniques can be applied to more than just trading. I will never forget in one of my interviews when he said "I am smart enough to know that I don't know where the markets are going."

LTCM Bailout Debate

January 14, 2007

This podcast brought in this feedback:

"Hi, I am a college student who is a big fan of your podcast. One of the ideas I like the most is this notion of accountability and taking responsibility for one's one actions. It's a theme that constantly comes up in your reports. I thought of this theme when I was having breakfast with Roger Porter, a professor at Harvard University and former high-ranking official in economic policymaking in the 1980s and 1990s. We were talking about the bailout of LTCM. We agreed that allowing people to experience the consequences of their actions is a good thing and about the craziness of this notion of being too big to fail. I immediately thought of the many times I have heard the same message in your work. Keep it up in 07!"

Another reader disagreed:

"You are incorrect. The Fed did not bail LCTM out. No US taxpayer money was used. A consortium of 12 banks took control of the fund by investing $3 Billion. It wasn't even a bail out. All the original principals and their investors of LTCM lost 99% of their equity in the fund. The NY Fed did help organize the bailout because the markets had frozen up under the fear of massive defaults. Go back and read "When Genius Failed" by Lowenstein. This doesn't invalidate any of the other good points you make regarding LTCM and their badly implemented strategies."

Nonsense. The supposed defaults should have been allowed. Read.

Real Life System Test

January 13, 2007

At Ed Seykota's web site he was recently asked a question by a reader who was risking 40-50% of his equity on each trade. Ed responded:

Hmmm ... you are risking 40-50% of your Equity on one trade. Professional trend traders typically risk around one percent as much as you risk. You can test your system a couple ways.

1. You can back-test it on a computer and notice it goes broke on small whipsaws.
2. You can run it in real-time, as you are doing. When you go broke, your test is complete.

Seykota, in an earlier response to another reader, offered wisdom to those looking for the 'end' of trend following:

Unwavering commitment to following a system is essential to making it work. Those who do not keep their commitments seem to generate justifying beliefs, such as the idea that the market's job is to derail systems. Such beliefs are consistent with the experience of abandoning a system - right before it becomes profitable.

James B. Stewart View for 2007

I just came across James B. Stewart's view for 2007. An excerpt:

This year, the first week's trading was an indication how much of the conventional wisdom rests on the assumption that the Fed has stopped raising rates, and will likely begin reducing them in 2007. To me, this is the biggest risk for believers in the conventional wisdom. Higher-than-expected rates could slow or reverse the drop in the dollar, dampening returns for foreign investments. The sharp pullback in emerging markets last year was triggered by rising longer-term interest rates in the U.S. and fears this would damp the global expansion. My hunch is that a similar scare will afflict markets at some point this year, which will likely represent a buying opportunity. But longer term, I think the conventional wisdom is right. Sooner or later, the Fed will begin to reduce rates.

Whew. Glad I read that. Now I KNOW what will happen this year! I did love Stewart's Den of Thieves however.

Real Time Quotes? Not the Solution

From the Wall Street Journal:

The New York Stock Exchange plans a pilot program later this year that could bring real-time stock-price data to millions of Internet users. The NYSE Group Inc. unit was expected to file a proposal with the Securities and Exchange Commission today. If the proposal is approved by the federal regulator, NYSE will sell to Web sites for $100,000 a month the ability to publish trade prices on the NYSE with virtually no delay. Web site operators including Google Inc. and General Electric Co.'s CNBC, have both agreed to provide their data to users without charge, if the plan is approved, and NYSE has also held discussions with several other Internet providers such as Yahoo Inc., said people familiar with the matter.

Isn't the implication that real time quotes for the average "investor" will "help" them? I just found the article odd. On the face of it real time quotes surely sounds great to most people. However, once everyone has real time quotes, does anyone expect that there will be some new class of super successful investors due to speedy quotes alone?

Quick Video Note on Amaranth

January 11, 2007

A short video clip from a speech of mine about Amaranth.

A Response to the Fastest Man in Michigan

January 10, 2007

A follow-up:

Michael-After re-reading your exchange with "the fastest man in Michigan" and after reviewing his response to my valid input AT LEAST FROM MY PERSPECTIVE, I am reminded of something my mentor [Name] told me in the early 80's. Early in our relationship I asked his opinion on XYZ or whatever. Here was his response: "[Name] I have learned over the years to never give anyone your honest advice. Firstly they will not take your good advice and secondly they don't need your bad advice so don't give 'em ANY advice!" I have learned over the years how true his belief continues to be on an almost daily basis.

Simplified Chinese Version of Trend Following Out

Full cover image.

Athletes Must Be "Unprogrammed"

Feedback in tonight about this post:

Given your exchange with the trader who is a former collegiate athlete, thought you might find this article interesting. The person being interviewed (a trading coach) makes a pretty persuasive argument that athletes must be "unprogrammed" in order to succeed in trading. As a former Naval Aviator I find (I'm biased, I know) that aviators actually have a pretty good mindset for trading given the focus on pre-flight planning and knowing emergency procedures.

Here is an excerpt from the interview the above feedback refers to:

StockTickr: Do you think trading and sports are similar?

Dr. Doug: Not really. In fact, I find I have to deconstruct the athlete mentality from most traders. You see in sports, you are conditioned to believe that if you fail you just need to work more on your weaknesses or try harder to get improved results. In trading this is not always the case and sometimes may even create more trading problems and even worse performance. Also, in sports you are taught to always think positive and to visualize the successful shot or throw. In trading, to be successful you have to first think about how bad things could get before you do the trade. You have to know, understand and be comfortable with your downside risk. Could you imagine a golfer before hitting a shot thinking about what he is going to do if he ends up hitting it in the water hazard? That is not what you or I or anyone would call a game plan for successful golf. Fact is athletes and weekend athletes should be spending their time visualizing success whereas successful traders have to spend their time imagining “what if” scenarios, disaster situations and how to employ solid risk management. Success in sports is about maximizing the upside, while success in trading is oftentimes more about controlling the downside and letting the probabilities play themselves out. On the surface sports and trading seem very similar, but go down a few layers and the mental game is quite different for each.

Read full interview here.

Accuracy Feedback #2 & Response

January 09, 2007

Feedback from an old pro trader who has made some great contributions over the last year:

Hi Michael-As always I continue to enjoy some of the exchanges you have with both seasoned and new traders. Early in my trading career I found myself hung up on the "need" to be right rather than the "desire" to make money. I learned early that being "right" of having a high % of winners had very little to do with my overall trading success. Those who have a need to be right with a high % of winners will find themselves passing on their best trading opportunities assuming they use some degree of discretion in their trade selections. One of my trading buddies enjoys a trading success rate annually of around 15% winners with 50% losers and 35% breakeven trades. In 2005 he made over 300% on his initial beginning of year trading capital and we are talking a 7 figure account not $10,000 so this guy is the real deal. He chooses not to trade public money for several reasons not the least of which is occasional drawdowns. This is a risk/reward numbers game and most who think it is something else usually face a "forced awareness" at some point in their trading careers. To further emphasize my point everyone has seen ads on the internet for systems being promoted for say a 90% accuracy. I bet 3/4 of these systems are based on a set of past criteria that have very little to do with their future performance. Let's say we do 100 trades in a calendar year. The average winning trade makes a net $100 so we make a net $9000 in the "winners". Now the bad news is the 10 losing trades are for $1000 so we lose a total of $1000 for the year in a system that had 90% winners. Now I realize this is a stretch from reality BUT mathematically this is what happens once a trader commits capital to the so-called "sure thing" trading systems! Have a great day!

The comment above brought in this feedback from the "trader" who originally talked of how important accuracy was:

I enjoy fanciful stories that say "My buddy made 300% on his intial capital". HAHAHA! LOLROF! This is a retort that is suppose to hold merit. That was Stand Up comedy. An this guy go on to say: "This is a risk/reward numbers game and most who think it is something else usually face a "forced awareness" at some point in their trading careers. To further emphasize my point everyone has seen ads on the internet for systems being promoted for say a 90% accuracy. I bet 3/4 of these systems are based on a set of past criteria that have very little to do with their future performance." He is saying "SHOW...ME...THE...RESULTS!" I'll show them NOW criteria. Let's do the experiment now Michael. TAKE THE CHALLENGE. I done this for 6 years and lost my trading account over 7 times from 2001 - 2004. This puts hair on your chest. Now my trading system is "Cut mine losses short" and "let's my profits run". Now I win and PROFIT consistently. You refuse to address PROFITABILIY! You only want to focus on accuracy. You ignore PROFITABILITY. PROFIT. PROFIT. +3% per month. Is this simple enough for you? Blake

Don't worry, I won't torture anyone with more from Blake. It is useful to see how the zero sum game works though.

Accuracy Feedback

Dear Michael, Allow me to indulge my thoughts with regard to this post that I found very interesting. First of all apologies if this is not the correct mail address to send this to but I could not find another way to reply to the post. To begin, it sounds like this chap has never had a serious loss and I hope he never does. The tone in his email is quite extraordinary. Just like the the athletes he described he was, they are the ones that if they start to loose competitions they tend not to be able to turn it around. The main reason being that they don't realise that loosing is part of the game. The only difference is how you deal with the losses that will ultimately determine if you will succeed or not. I say this because I was a promising football player (or soccer I should say) in England until several substitutions during games caused doubt in myself and I slowly but surely disappeared from the scene. Ultimately where I think he is mistaking is equating frequency with magnitude. I won't even go into monthly return target that he appears to be setting. That's a recipe for disaster. The market just doesn't allow you nor are their enough opportunities to do so unless you take huge leverage. And we know what can happen then....In sports, frequency equals magnitude. That is, your number of tournaments/competitions entered (frequency) will equal to the number of races won or lost (magnitude). In trading this does not. You can be wrong over 70% of the time and still have a positive return. The reason being that magnitude in trading has a component to it called risk management. The old adage "cut your losses short and run your profits" is probably the oldest cliché in the market place but one whose power is often overlooked and misunderstood by most participants, professionals and non. Kind regards, Leonardo Cecchini

Round and Round Over Accuracy

January 08, 2007

The following email conversation with a new trader is useful education for all.

My website was up briefly in February 2006 but I felt it was not ready for public consumption. My accuracy was only 50% and that is not up-to-par in my opinion. Now my accuracy is +75%.

My response: Ok. But great traders are not aiming for "accuracy." You are on board why that is not a wise pursuit? You see what I have said about it?

My financial goal is 3% return per month. I must make profits is the name of the game. My trading model must be better than 66% accuracy to be worth its salt. It has to be reliable.

My response:

Listen: http://www.turtletrader.com/mp3/tips.mp3
Read: http://www.michaelcovel.com/archives/000161.html
Read: http://turtletrader.com/babe-ruth.html

Michael, The advice you gave me was for a rank amateur.

My response: You were emphasizing percent accuracy and how important it was. Why? It's not.

Michael, I'm sorry for taking too much of your time. I can see you don't believe (and why should you) that I have the goods to be an effective trader. The 6 month (or 3 Month test) would be the proof in the pudding but.....I will be on CBNC next week on Fast Money @ 8 P.M as a webcam guest.

My response: Why are you so defensive? Why don't you address the accuracy issue I have raised - and stop the other stuff. I know of NO successful hedge fund manager who shares your view on accuracy.

So does Paul Tudor Jones, Bruce Kovner, and Steve Cohen win on less than 20% - 33% of their trades?....I DON"T THINK SO. Because, if this is the case, then they are fundamental traders, which they are not, and would just run with the pack of Mutual Fund traders who barely beat the SP 500 yearly. Astute Technical Analysis will generate better than 50% efficiently.

My response: Winning percent doesn't matter in the abstract. You are up with the concept of expectation? That's what they worry about.

You said "Do you understand the concept of expectation?" I played Division 1 football, Was the top rated 100 meter runner in the State of Michigan and was my High School's 1st track captain in the 10th grade. We call it "PUT UP or SHUT UP". In sports, the skilled position players cannot hide. In the 100 meter sprint there is no excuses. Either you beat the field or you lose...Period. Of course I understand expectations. Everyone loves a winner and expects him to keep winning. Napoleon said "a Winner has a thousand fathers...a loser none". Also, Steve Cohen has 20+ years of consecutive winning years. His fund has been closed off since 1998. This has earned him legend status and people want in. WHY? They EXPECT THAT HE'LL WIN. Simple. This is Wisdom.

My response: We are missing each other. There is a fair example of mathematical expectation in my book Trend Following.

Jeff DeGraaf: Technician?

January 06, 2007

Feedback in tonight:

Michael, thought you might find this list (PDF) interesting. Jeff DeGraaf is one of the more respected technicians on the Street, whatever that means.

That report is one of the reasons so many are confused when they first try to absorb trend following trading. That report is the predictive technical analysis that I write about in my book. I don't know what to do with it, but it sounds nice.

Ace Greenberg Audio and Personal Story

A great audio clip interview with Ace Greenberg. Top notch wisdom from Bear Stearns legend. Requires free REAL player.

A reader added a personal story about Ace:

I sat across from Ace when I was a grunt intern one summer at Bear during college. I used to ask him questions whenever I could. The two things that stood out in my mind: 1) I asked him what the great trades had in common. He said the best trades in hindsight were the ones he felt like he was gonna throw up at the time he initiated the trade and the trades he felt most comfortable with were the ones that killed him; 2) Also he said then that understanding, and allowing yourself to take a loss was the most important thing in the business.

2006 Example Trend Following Performances

January 05, 2007

Some sample trend following performances from 2006:

1. Superfund (PDF)

2. Winton Capital:

The Winton Futures Fund gained an estimated 2.20% in December to bring the full year performance to 17.90% and the compound annual average rate of return in 111 months of trading to 19.36%.

3. Abraham (PDF)

Np one said their ride was without volatility, but their long term patience seems to reward nicely.

When All Else Fails, Hedge Your Bet

January 04, 2007

Two excerpts to consider:

"Oil Falls to Six-Week Low as Mild Weather Crimps U.S. Heating. Fuel Demand Crude oil fell to a six-week low in New York and a one-year low in London as mild U.S. weather curbed heating-fuel consumption."
Bloomberg 01/04/07

"Nymex Gas Rises on Forecasts for Colder Weather in the U.S. West Next Week Natural gas rose in New York on weather forecasts showing colder air spreading across the western U.S. next week, snapping a four-week trend of higher- than-normal temperatures."
Bloomberg 01/04/07

The ultimate news hedge!

Byron Wien Announces Ten Surprises for 2007: Would You Bet on These?

Pequot Capital Chief Investment Strategist Byron Wien has compiled his 22nd annual list of "ten" surprises for 2007:

WESTPORT, Conn.--(BUSINESS WIRE)--Byron R. Wien, Chief Investment Strategist of Pequot Capital Management, Inc., today issued his list of Ten Surprises for 2007. Mr. Wien has issued his economic, financial market and political surprises annually since 1986. The 2007 list follows:

Mr. Wien believes these surprises, which the consensus would assign only a one-in-three chance of happening, have at least a 50% probability of occurring at some point during the year. In previous years, more than half of the elements of the list have proven correct.

Would you bet your money on this? If you decide to bet, how much are you betting?

Google Hiring Practices

January 03, 2007

There is an interesting story in the NY Times about Google's hiring practices. An excerpt:

Unfortunately, most of the academic research suggests that the factors Google has put the most weight on — grades and interviews — are not an especially reliable way of hiring good people. “Interviews are a terrible predictor of performance,” said Laszlo Bock, Google’s vice president for people operations. “With traditional hiring methods, we were worried we will overlook some of the best candidates.”

The Turtles were originally screened by primarily intelligence tests and then for a games playing aptitude. As they learned, and as Google is learning now, there is always something else to success than pure IQ. In Google's case it is worth noting that almost every new hire is going to be support staff by the nature of their expansion. It's the core leaders at Google, the core engineers, who made it happen and control all.

Turtle Casting Call: What Do You Know?

January 02, 2007

A few months back I announced my new upcoming book on the Turtles. The book is in the publishing edit process, but it was a conversation I had today that prompted me to write this unusual post.

What happened? I spoke with a trend following trader today. Due to a non-typical career path, he has had a very quiet and successful career over the last twenty years. How successful? He has earned himself a fortune close to $100 million dollars. Frankly, I felt stupid to not have heard of him! In conversation, he suddenly offered a Turtle connection. While he had no association with Dennis or the Turtles in developing his trend trading method (Donchian influences), he did receive advice from a Turtle early in his career about how to setup his trading firm (dealing with legal, etc.). It was the kind of nugget that just continues to make the Turtle story, with all of its tentacles, such a small world story. I KNOW this trader is not the only one with interesting experiences with Turtles over the years.

What does this mean for readers of my blog? Well, the randomness of today's conversation got me to thinking that I should be asking EVERYONE if they might have a FIRST HAND anecdote or story about the Turtles in some way or another that would be interesting. I am interested in your small bits to big stories. If you do have one, contact me ASAP. There is no guarantee that your story will make it into my Turtle book, but if it is good, now is the time to contact me. DEADLINE? Now.

The Pyschology of Regret

January 01, 2007

The recent Yahoo! Finance article The Psychology of Regret (PDF) is good food for thought.

Ranking for January 1, 2007

It has been a while since I gave the self-serving update of an Amazon sales rank for Trend Following. A January 1, 2007 ranking of #1951 of all books available on Amazon says a good deal about the desire of people to find a non-fundamental way of making their trading decisions. The book was originally released April 23, 2004.