The
last seven days have provided me a typical opportunity to respond to readers and
carefully observe the "news". Hopefully, some of my pieces here will
remind all traders why it is so important to think for yourself.
One Day's Movement is Noise
From TheStreet.com:
"The rally that began this year was so
strong that you have to give the bulls the benefit of the doubt and assume the
rally could continue. It's still early to get extremely pessimistic, but the
bulls should view the overnight selloff as a warning signal. The groundwork is
being laid for a move to the bottom of the channel."
Ken Tower, Chief Market Strategist with
CyberTrader
I have met Ken. He comes from a technical
perspective and we have talked 'trend following' as he has read my book. I know
his comment is most likely the quick response to a deadlined reporter, but I
have to disagree. Trying to give a historical accounting to one day of market
action has no real purpose. One day of market action, unless it is a major
market crash, is nothing but noise. There is no concrete way to divine market
directions from one day. Yes, perhaps it is a small bone to pick with Ken, but I
feel it is an important one.
Investor or Trader?
From Morningstar.com:
"What makes Greenblatt's [book:
The Little Book that Beats the Market] message valuable is its focus on
investing as opposed to speculating. Investing involves risk, but it is not
buying something with the hope that you'll be able to sell it to someone else
for a greater price later. Investing is financing the operations of a business,
and it involves trying to understand if that business is healthy enough and
profitable enough to give you an adequate return on your capital from its
operations, based on the price you've paid for your interest in those
operations. This is what Warren Buffett has called a "business" approach to
investing, and it's the one we favor at Morningstar both when we analyze stocks
and when we evaluate the investment processes of mutual fund managers. Our stock
analysts prefer free cash flow yield instead of earnings, as they believe free
cash flow is a more accurate measure of the amount of cash that can be lifted
out of a business without disturbing its operations. They also use something
called a discounted cash flow analysis to value the stocks they cover, but the
principles are the same as Greenblatt's."
Is it easier for the average person to wrap their
arms around the idea of "financing the operations of a business" or simply
trading based on daily price action? Is it more realistic for the average person
to be an "investor" or "trader"?
5 Questions You Need to Answer...Correctly
Here is a discussion I had with a trader the
other day. We were talking about the 5 questions presented in Chapter 10 of my
book Trend Following. He forcefully responded:
"...here are my methods in order of the five
questions:
1. I only trade stocks...most of my money is in
IRA's, I rarely go short.
2. I always buy an equal dollar amount on each trade.
3. I use technical analysis for buy & sell signals. Trend lines, etc.
4. Same answer as #3.
5. Same answer as #3."
Let me restate the 5 questions:
1. How do you determine what market to buy or
sell at any time?
2. How much of a market should you buy or sell at any time?
3. How do you determine when you enter a market?
4. How do you determine when you exit a losing position?
5. How do you determine when you exit a winning position?
This trader has a blind spot. That blind spot
lets him believe that his answers comprehensively address the 5 questions. His
answers need to go further.
The Trend Following Debate
Feedback from a reader:
"Mr. Covel: I've been trading since 2003 and
have devoured many trading books. Trading with the trend is not a new concept
which makes me wonder why anyone, such as yourself, would write a book entitled
Trend Following. That's like reinventing the wheel. Any idiot with an
understanding of technical analysis, good eye for bullish price patterns (in an
uptrend) and bearish price patterns (in a downtrend) and a disciplined approach
to risk management can make money in the markets. After successfully trading the
uptrend of 2003, I stumbled over the sideways markets of 2004 & 2005. This has
become a hard and expensive lesson for me. Real brilliance is attributed to the
trader who can make money in the sideways and choppy markets and I have yet to
find anybody who has written a good book on how to do that. Rich O."
Some points to consider:
1. Great traders don't make big money in sideways
markets. Great traders use risk management during sideways markets to stay in
position (and preserve capital) to catch the next up or down trend.
2. Great traders do not use predictive technical
analysis, they use reactive technical analysis.
3. I have not seen evidence that any "idiot", as
you say, can trade successfully. Greatness in all pursuits takes hard work. Hard
work is not something that all people want in their lives.
4. The book
Trend Following has sold over 50,000 copies. It fills a void in a
marketplace inundated with books about finance and trading but lacking any
resource or, for that matter, practically any reference to trend following
trading.
More Feedback:
"I am a great believer in trend following and
have found your book to be most useful and informative. I also enjoy reading
some of the trend following excerpts that you pass on in these emails. With that
said, might I make one suggestion? On occasion, you seem to have a need to go
'toe-to-toe' with the naysayers of trend following. I think, perhaps, that
entering into these verbal 'wars' only ends up lending some credence to their
position by even acknowledging their existence. Trying to change the minds
of these 'buy-and-hold' and CNBC puppets is like the old story about trying to
teach a pig to sing - it accomplishes nothing and it really ticks off the pig.
Just a thought for consideration: continue to promote and educate those who are
just trying to get into investing about the benefits of trend following. Stick
with the positive promotion of trend following and leave the 'naysayers' alone
on their meaningless battlefield. Don't waste your energy fighting people who
have already made up their minds. Save your energy to help those who have not
yet been brainwashed. Getting down in the dirt with those who put down trend
following may tend to discredit the very important message you really want to
get across to those who need it most."
Breaking in with a Hedge Fund
A question that came in today:
"Dear Michael, I am a young trader and have
developed a passion for the markets over the last three years. I am also
extremely interested in your research and frequently refer to your book/websites
for insight. It is always inspiring to hear about successful traders, and I look
forward to reading more of their stories through your work in the future. I have
a question about pursuing trading as a career. Currently, I am a first-year MBA
student, and many of my colleagues are searching for internship opportunities
for the summer. It would be exciting to gain some experience with a professional
trader, although I understand that positions at hedge funds are extremely
difficult to come by. Still, I wanted to see if you had any suggestions or ideas
that might be worthwhile to pursue, either with an up-and-coming trader or a
fund willing to extend an opportunity to someone new to the business. Any
information would be very much appreciated. Sincerely, Jeff M."
Good question. Unless you have a contact through
friends, family, etc., an intern position is hard to come by. If you only need
20 employees to run a billion dollar fund that doesn't leave many spots for
interns - especially in an industry that stays 'low profile'. You may also
consider the mind set of many great hedge fund managers: they often started with
little money as one man shops. If you really want to be "them", working
for them might not be the way to get there. If you want to be them it might be
best to emulate them.
New Study on Momentum
A recent piece of research titled
Research Reveals
Why Some Stocks Keep Winning, While Others Keep Losing (PDF) outlines new
academic thought on momentum trading. An excerpt:
"A new study suggests that investor
psychology plays a big role in why stock prices show strong momentum - the
tendency for prices to continue in the same direction, either rising or falling.
Theoretically, with the information in this model, investors could measure price
momentum more efficiently and earn more in the stock market, (Bing) Han said,
(assistant professor of finance at Ohio State University's Fisher College of
Business)."
Why is this news? Have trend followers not been
taking advantage of momentum for decades to make money? This professor is only
at the "theoretical" stage, when trend followers have been living these concepts
to the tune of billions in profits for some time.
Michael W. Covel is the founder and
President of Trend
Following. A researcher of the most successful Trend Following investment
managers, he has been in the alternative investments industry consulting on
Trend Following to individual traders, hedge funds and banks for ten years. His
best selling book,
Trend Following: How Great Traders Make Millions in Up or Down Markets, New
Expanded Edition (Prentice Hall, November 2005) is a complete and concise
guide to trend following. It includes interviews with great trend followers who
have won millions if not billions in the market. The trading world has embraced
the book with endorsements from Van K. Tharp, John Mauldin, Ed Seykota and many
more. Trend Following is now in its fifth printing, and is currently available
in a Japanese translation with Chinese, German, French, Korean and Russian
translations soon to follow. Teaching and sharing unique insights about Trend
Following trading and alternative investments has earned Mr. Covel respect as a
rational and logical voice in uncertain times. Mr. Covel also writes for
numerous industry publications including Your Trading Edge, Stocks, Futures and
Options Magazine and International Petroleum Finance and is consistently quoted
and interviewed by a variety of financial publications.
Mr. Covel is also Managing Editor at
TurtleTrader.com, the
leading Trend Following news and commentary resource since 1996. Thousands of
visitors from more than 70 countries as well as hundreds of trading
professionals engaged in years of debate and interchange making the site the
rich archive of trading information, data and opinion that it continues to be
today. TurtleTrader, one of the largest & strongest trading community on the web
with over 7.5 million unique visitors since its inception, also functions as a
resource center for the Trend Following Educational Course.
