Time to think it through

Most readers know by now that I will not be touting the stock of the week or some inane research. I am infinitely curious, so I am always searching for those aha! moments. The following morsels of information, blog entries if you will, should prove thought provoking to even the most jaded of market players:

K.I.S.S.

Here is some great feedback from a reader on "simplicity":

"I found your interview dated November 7, 2005 interesting and enjoyed it very much...I personally know quite a few trend followers that adhere to the idea that systems drift over time and need to be tweaked. Such traders sow the seeds of their demise. They lack the tendency to idealize, and instead pay attention to small features and choose to ignore clarity and simplicity. Their ideas (not methods) are not scientific. Such traders lack the ability to translate their ideas into firm trading rules. They add complexity and noise when they should be doing the exact opposite. Science is about principles and principles that can be dated are not principles. The supreme task of a trader is to arrive at a broad principle that addresses the trading process - the profit generating mechanism. And such a 'principle' can be assimilated, validated, corroborated and verified. From this principle, a system that will not be dated can be built by pure deduction. Many have difficulty understanding how one can make money through a disciplined use of a simple volatility based money management system. They are conditioned to think in linear terms where cause and effect are clearly linked. They don't realize the simpler the theory the less it will look anything like the world they see. The key to really understanding the profit generating process is not system optimization, endless estimation, and blind number crunching. While facts reside in the real world, principles reside in the mind. These traders attempt to start by looking at the data and try to 'warm the general principle out of the system.' And as the data drifts over time, the supposed principle gets dated. To find principles that stand the test of time requires a leap into the unknown, into the darkness of our mind and feelings where imagination and intuition hide. It is cognition resting on sympathetic emotions which hopefully lead to the first principle. Only then do we test the validity of the evidence by observing how well it fits the theory - the first principle..."

This is one of the best emails I have ever received. To the point and on the money.

Bet Sizing Research

Michael Mauboussin of Legg Mason offers this recent research on bet sizing (PDF). An excerpt:

"Edge is key. Recall the foundation of Kelly's model rests on having a view that is different, and more correct, than that of the market. Having an edge requires understanding the market's perspective. As Poundstone writes, 'The stock ticker is like a tote board. It gives the public odds. A trader who wants to beat the market must have an edge, a more accurate view of what bets on stocks are really worth.'"

India Calling: Martin Capital Management

Michael Martin of Martin Trading is covered in this interesting piece (PDF) about his trend following trading exploits in India. An excerpt:

"As evidenced by the presence in India of the guys from Martin Capital Management, the country also offers the opportunity to take proprietary trading systems and apply them to the Indian market, either on one's own behalf or as a service to others. Over drinks at Geoffrey's Pub in Nariman Point, Martin's Christopher McCauley describes what they're doing as a form of "in-sourcing" -- providing Indian investors the ability to layer a trend-following function on top of their capitalization or style-focused investing strategies."

Michael also contributed some great side margin quotes for the revised edition of Trend Following released November 2005.

No W.D. Gann

A reader laments the "bad" literature on trading available:

"Dear Mr. Covel, I bought your book, Trend Following, because I liked another book by the same publisher. I noticed that in the index, there is no entry for '(W. D.) Gann.' There is no entry for 'Elliot (Wave).' So far, so good. I decided to read the book. I haven't run across any advice like, 'If you want 4:1 risk reward ratio, buy things that are going to go up 40 points and put your stop 10 points below your entry point.' So far, so good. I'm going to read the rest of the book. Thank you for writing a unique book. I know the word 'unique' gets used a lot, but, in this case, I believe it to be the correct term. Chuck C."

Thanks for the nice words Chuck. Wrapped in your compliment are key pieces of wisdom for the Holy Grail crowd.

Trend Following in Ohio

Feedback from a manager of a $2B dollar equity portfolio:

"I manage a $2 billion equity portfolio. One of my primary strategies is trend following. I have been roundly criticized by my fellow portfolio managers and analysts who believe that a DCF (discounted cash flow) model is the answer to successful investing. Sometimes it's very tough explaining that the reason I own a stock is because it's going up. That's too simple for these University of Chicago trained MBAs and CFAs. But some of them are slowly coming around to trend following because they see the results. Over the past 3 years I have outperformed my benchmark by about 800 basis points, while the other portfolio managers are consistently failing to beat their benchmarks. After managing money for over 12 years, I am absolutely convinced that trend following works."
(Name Withheld), CFA Portfolio Manager
Ohio Teachers Retirement System

The great insight from this type of feedback is that it presents a view of trend following from someone you might not first expect it from.

Drawdown Clarification

Feedback from a reader regarding drawdown:

"I am not sure where to send my question for Michael. Here it is: It is clear from his book that trend following is neither fundamental analysis nor technical analysis. Trend followers enter the market when the trend is in the early stage and they quickly exit when the trend reverses to limit the losses. Yet, the book talks about drawdowns in trend followers' portfolios. Does not drawdown mean that the trend went against them? It (seems) counter-intuitive."

Drawdowns result from trend-less periods. Drawdowns result from the many false starts that produce many small losses during choppy market periods. Also to clarify, I do not say that trend following is not technical analysis. I say that there are two distinct views of technical analysis and trend following is the "reactive" view.

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.