David Merkel: Defending A Wrong View to the Bitter End

This review caught my attention:

This review is unlikely to make me friends, and likely to generate some negative mail. Let me start with the conclusion: don’t buy the book. That said, my reasons for stating this are different from those who typically criticize Michael Covel. I agree with much of what he says; I disagree with much of his rhetoric. Let me give you my thoughts:

1) Momentum is a pervasive factor in the markets. It works about 80% of the time and produces significant excess returns on average. Behavioral finance points out that people are slow to adapt to new information, so momentum tends to work because the initial moves on new information aren’t sufficient. That said, when too many are chasing momentum, the market becomes extremely volatile, and the strategy ceases to work, until it shakes out enough momentum-followers.

What is hard, is distinguishing trend following from technical analysis from momentum. Personally, I think momentum explains the other two. It’s a much simpler theory, and much as Covel appeals to Occam’s Razor, I apply it back to him here.

2) He draws on a series of investors that have done well in the past, and touts them as proof of his theories. Hindsight is 20/20. What of those that have tried to apply trend following and failed? Is it many or few?  Keeping a tight stop loss for some means the death of a thousand cuts. The studies that I have seen show that frequency of trading tends to decrease returns.  Now, trend following does not necessarily mean a lot of trading, but for many it ends up being that way.

It is easy to locate a bunch of trend followers in hindsight, and tout their abilities. What would be harder would be to find the whole universe of people following trends, and see how they do as a whole.

3) Mean reversion is a weaker factor, but still significant in making money. Value investors typically do well with it, but only reliably when they insist on strong balance sheets. I’ve studied mean reversion for years, and it exists in almost all markets as a weak factor. Over enough time, that weak factor has punch, but in the short run, momentum rules on average.

4) Covel spends a lot of time trashing fundamental analysis, without much meat behind it. Fundamental analysis works well, but doesn’t have so much value because so many are applying it. It’s not like the situation Ben Graham found, where few were doing it.

Aside from that, technicians implicitly rely on fundamental analysis, because their support and resistance levels stem from the decisions of fundamental investors. Same for those that follow trends. The trends exist because fundamental investors react slowly to changes in the fundamentals, and trend followers exploit them.

5) There is no mention of the Adaptive Markets Hypothesis, and little discussion of Behavioral Finance. These are much richer theories that encompass ‘trend following.’

6) Covel takes ‘pot shots’ at Buffett over issues that are unrelated to his main point in an effort to discredit him. Buffett is a bright guy who can criticize derivatives in aggregate, while still using them in specific to his advantage. (Cough, cough.  Please ignore his put option trades.)

7) There was not enough time spent on ‘how to trend follow.’  After reading the book, if I didn’t have prior background knowledge, I would be scratching my head to figure out how I could reliably pick investments in a trend following mode in order to make significant excess profits, as well as know where to sell them.

I don’t recommend it, but you can buy it here: Trend Following (Updated Edition): Learn to Make Millions in Up or Down Markets.

Final note – Covel needs to grow up and learn that there are other factors in the market aside from momentum.  He has become a fundamentalist about ‘trend following’ and does not seem to have the open mind that he harps about.

PS – Remember, I don’t have a tip jar, but I do do book reviews.  If you enter Amazon through a link on my site and buy things from them, I get a small commission, and you don’t pay anything extra. Such a deal if you wanted to get it anyway.

Who is Merkel:

David J. Merkel, CFA, FSA — From 2003-2007, I was a leading commentator at the excellent investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and now I write for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I still contribute to RealMoney, but I have scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After one year of operation, I believe I have achieved that.

A Cramer trainee.

You might like my 2017 epic release: Trend Following: How to Make a Fortune in Bull, Bear and Black Swan Markets (Fifth Edition). Revised and extended with twice as much content. Out April 24th 2017.

36 thoughts on “David Merkel: Defending A Wrong View to the Bitter End

  1. Michael, I love your book. It actually changed my view of investing. But I think it’s tacky for you to comment on and respond to negative book reviews, especially ones appearing on Amazon.com, of all places. It’s just not necessary, and just makes you appear overly defensive and a bigger target for your detractors. Try keeping your nose above the fray a little more.

  2. David, why not respond to his points rather than name calling? His point on survivorship bias is valid. I would also add the trend follower’s use of leverage makes comparison with unlevered ‘long only’ funds returns ‘unfair’.
    I agree with the bloggers point that you are a fundamentalist in the sense that you refuse to think there is any other decent way to trade/invest.
    I strongly disagree. There are many ways to bake a cake and if you use wide database searches like FSRC on Bloomberg that catch nearly all funds over long periods of time, you will find them there.
    Full disclosure, I am a trend follower but also, an investor in traditional style funds… those that focus on returns via asset allocation more than stock selection, with an underlying Mises/Hayek philosophy. It should be no surprise that these funds have ALSO done well in this period.

  3. Jim, fair point on “defensive”, but trend following is still not known. Investing for the vast majority of people is a one party system — “Buffett-fundamentals-buy and hold.” Trend following is not on the road map for 99.9% of investors. If/when most people have actually heard of trend following, I will heed your advice and dial back the “defensiveness”. But until that time I will get in the ring with folks like Merkel because folks like Merkel are the very reason so much of the American public don’t have a clue on how to handle their investments.

  4. David, on the survivorship bias issue (and clearly I don’t buy it), does it apply only to trend following? Not to Buffett?

  5. Two Questions:

    What is Merkel’s investment track record?

    Where are his audited results?

    Go through alphaseek.com and check his articles from 2007 onwards, especially the one’s from 2008 before the big meltdown.

    Here is just one nugget of beautiful investment insight from a great fundamental mind:


    “If Prudential (PRU) drops much further, I am buying some. With an estimated 2009 PE below 8, it would be hard to go wrong on such a high quality company. I am also hoping that Assurant (AIZ) drops below $53, where I will buy more…There are quality companies going on sale, and my only limit is how much I am willing to overweight the industry. Going into the energy wave in 2002, I was quadruple-weight energy. Insurance stocks are 16% of my portfolio now, which is quadruple-weight or so. This is a defensive group, with reasonable upside. I’ll keep you apprised as I make moves here.”

  6. Merkel added:

    “Covel should spend more time on the behavioral finance literature, study the anomalies, and then tell me — how is trend following different from momentum? I am a value investor that uses momentum positively in investing. It works, marrying a long run factor and a short run factor.”

    What does this mean?

  7. I have known david for a longtime through correspondence and his comments are meant for thoughtful discussion from my view. I think “Cramer trainee” is not the right viewpoint from reading all his commentary. David’s writings are not idealogy for “buy and hold”. These type of discussions from all parties are very helpful to improve anyone’s investment decision making.

  8. Paul in KC, as I stated:

    “Trend Following” is a subject that the vast majority of investors have never heard of — even though track records showing its success go back decades across many traders (not just one icon as in the fundamental world). That said David, I am willing to consider your “marrying a long run factor and a short run factor” investing style. Keeping with the spirit of my book, a book backed by audited performance records month by month, where can I find the performance records of this style you speak of?

    Note: Do I expect that there are audited track records of this alternate philosophy? Not really.

  9. Trend Following is a great investment read, whether you subscribe to its premise and logic or not. I’m not certain, mostly because, everything I do is trend following on some level or another, even the one-minute scalping charts. As for behavioral science, I suspect an understanding of Prechter or Neely would suffice, although I think I can argue that both are trend followers when you cut through all the numbers and letters to the meat of their techniques. In summary, great book, probably a good way to approach markets and diversification and on top of all that, one of the better blogs in the investment blogosphere.

  10. Fundamental investing presupposes that one knows more than the market, that essentially the market for that security is somehow wrong. It is the quintessential ego play, as one is therefore smarter than the market. This incidentally explains why so many “good investors” were blown up by the market: they take positions, the market moves against them, they buy more, their ego will not allow the possibility that they are wrong. This is why the market killed longs like Bill Miller and hedgies like Amaranth or Niederhoffer.

    Trend following presupposes that one can never know more than the market, that the market, despite its apparent randomness, is always right. The real irony in trend following is that it is based on fundamental investing at the margin. Securities are priced at the margin by intense supply and demand of that specific security. BUT, it is the sum total of the supply and demand which moves the market, and as information is discovered by more and more investors, a trend is formed.

    Therefore the dispute between the fundamentalists and the trend followers lies in the differential between what one believes he knows. The fundamentalists believes that he is smart enough to outthink the market, to somehow know more than the myriad of inputs into the complex system, and to then translate that into an investing decision. The trend follower believes that he could never be smarter than the sum total of “smart investors” pricing the security at the margin… as well as the continual marginal information being priced into the security during the day.

    Guys like Merkel are just examples of egos who cannot accept that a concept like trend following can work, as it doesnt take minds like soros or robertson to make money. It is almost like they believe you need to be some avant thinker to make money in the markets. They need to justify their education, their backgrounds etc, in order to satisfy some justifiable performance equation in their mind. They cannot stand the fact that something as seemingly simple as trend following could better their fundamentally-based results. What they continue to misunderstand, and the key to the entire trend following method, is that trend following not only checks its ego at the door, it USES fundamental investing in tota, as its foundation. THAT, i think, is the great and unseen irony in trend following.

  11. Can you benefit without price trends? No way, this is like trying to drive the car backwards in opposite direction to where you want to go.

    Can you buy or sell CNBC news? No, how can you build a relationship between the news and your profit/loss?

    Therefore you need math to measure risk directly.

    Trend following is just a very general name to the process of profiting by being in the direction of the trend, a little kid agree on that.

    Fundamental analysis is also good when added to the technical model, for example i would trade less before some news release that may create high volatility.

    Fundamental analysis is useful to forecast times where risk may increase, it’s like an extra sensor which may prevent direct damage to your bumper.

  12. I find the amount of time people will spend arguing about trading or investing styles rather odd. I can only surmise the reason people do this is to facilitate the sale of their particular style to the public.

    If you have a style or plan that works well for you I would think you may just want to keep it to yourself.

    Unless of course you are a true humanitarian and you feel compelled to “give” your great gift to all mankind.

    But then if it is a gift you wouldn’t have to defend it.

  13. Hey Michael,

    why don’t you just run a real trend following portfolio and prove all your critics wrong? I’d also suggest you publish the portfolio’s track record with a higher frequency than monthly figures (daily?). Moreover, you should describe exactly how you go about the strategy. That should not be a problem, just use one of your trend following strategy you sell (in/after your seminars). This would gain benefit all…

  14. I defend trend following because 99.9% of investors have never heard of it. And those that have heard of it usually don’t get what it is, i.e. Merkel. In terms of your other issue, I have written two books on the subject of trend following trading. Solfest if you don’t want to spend the approximate $15 for each, then you don’t have to buy them. However, if I follow your nonsensical “humanity means everything should be free” logic, we might as well do away with commerce. Why pay for a car? The factory can build it for you for free out of the goodness of their hearts. Need attorney? He works for you for free, etc. Come on!

  15. Thanks Rob, but I am not acting as a fund manager for clients nor do I have a desire to do so. I am providing education and information. Many people seem to appreciate that. I am not attempting to keep anyone forever hinged to what I have to say, like the fundamental guys must do. In terms of critics of trend following, performance numbers are clearly not the issue. If the performance numbers of the traders I post mean nothing to you, and if your first reaction is say they are all “lucky”, I can’t change that view.

  16. Let me start by saying that I’m still going through the book and I’m glad you wrote it.

    However, I am very disappointed by this discussion thread. If you knew nothing about the subject at hand, and just read the back and forth, it would be very clear that the “counter-arguments” don’t even address or try to understand the “arguments” and are largely illogical.

    I too am a huge fan of furthering knowledge, but this is not working.

    It could be made to work.

  17. I think that one of the major points that I have taken from books about trend following is that the exact “rules” that an individual may follow in his strategy are really only about 25% of the story. To publish a list of trades is a nice concept, but one of the things that always comes out loudly in numerous books is to make your OWN decisions. The rules that the turtles used have been published, how many people have followed them ? I have my own rules that fit with the amount of time and frequency that I wish to trade, they will I am sure be different to everyone else’s. The psychology of trading is I believe more important than the rules that each individual may use .

    I am very grateful for Michaels books in sending me down a path of educating myself ( by reading many other books, not just his ! ) and not relying on others to form my opinions for me.

  18. Michael I did buy both of your books, and Faith’s book (sorry about that). I enjoyed and learned from all of them.

    My point about trading styles is that you and Merkel are both defending your styles because you both earn income from the promotion of these styles. I have no problem with such commerce but it may not make either one of you the most objective author on the subject.

  19. Solfest I don’t care what books people buy! 🙂

    In terms of a style battle – I disagree. Merkel has not defined a style, he has defined a theory. The style I write about has performance we can all look at. Where is the Merkel market theory in performance results? Also, I would re-read Sandy’s post above.

  20. Paul I indeed earn revenue from passing along insight/information to others. Education is what I do. Obviously, having been at this for some time, the information has value. Merkel indeed is paid for his information, regardless of how you want to split hairs. What I find amazing about this “debate” is the number of red herrings being thrown around – like they somehow refute the content of my book. The debate for some is clearly everything except “trend following” (and especially that 08 trend following performance). I don’t find it all surprising that those with a fundamental bent would do everything except argue the strategy on it the merits.

  21. Merkel is a paid professional at Finacorp; but I don’t think it is splitting hairs;selling books or website services is a different business. I don’t think it is accurate comparing what the two of you do OTHER than the blog. (BY the way;i think it is great you are making money doing this!) I may be reading a tone that doesn’t exist but i have not made ANY negative statement regarding trend following; quite frankly I believe it works well enough; just tell me when the trend changes! 🙂 I have nothing to write that in anyway refutes the content of your book; i owe you a book purchase for the time given; but I think discussing data mining is always relevent but it may not be helpful; after all almost all of our decisions are based on past experience i.e. data mining.

    I have only pointed out inaccuracies regarding Merkel as I have read them. Again; I am friends with the guy but “seeker of truth’ is as good as description as any; I know; just call me Pollyanna from Kanas City.

  22. Michael, I bought your first edition Trend Following book, and I will say it was useful in terms of introducing an alternative investment methodology to fundemental research. Having said that, the way your reacted to David Merkel is juvenile and unprofessional. Mr. Merkel is right about you needing to “grow up.”

    If you are going to self-appoint yourself as an evangelist of Trend Following, at least try to hold an intelligent discussion/debate w/ people you disagree with. They are not enemies. They only hold different points of view.

  23. Synchro no apologies from me. We have all witnessed a world fleeced by buy and hold/fundamental nonsense for a generation. You are aware of the fees charged by mutual funds to deliver nothing over a decade? Additionally, praising Cramer while simultaneously misstating trend following does not equal intelligent discussion and debate. And Paul in KC, I don’t know what a “paid professional at Finacorp” is. There were a whole bunch of paid fundamental “professionals” over the last 25 years. I don’t care for the vast majority of the whole lot.

  24. Micheal,
    I would have to admit that i agree with Mr Merkel, as i had a similiar outlook as he did when i first read your book a number of years ago. I am a mechanical trader, and many of my systems could be identified trend following. That being said, i am not a trend follower, i am a system trader who has developed a number of stastically significant approaches. Unfortunately Michael, you are too one eyed for your own good – there are heaps of ways to skin the market, and just because a couple of trend followers are consistently profitable, does not mean the rest are irrelevant. You do a good job, you just need to relax your approach.

  25. Commenter “GrowUp” (#17) feels the merits of Merkel’s “argument” have not been addressed. I’ll examine some of Merkel’s points.

    1.- “Momentum works about 80% of the time.” Where does this statistic come from? This is nonsense. How does one define “momentum?” What happens the other 20% of the time? Do you go bankrupt? Do you lose half your money? How do you define “of the time?” Do you make money 8 out of 10 years? Months? Weeks? The fact that Merkel starts his review with a fabricated statistic that says absolutely nothing should ring some alarm bells immediately.

    2.- Merkel then points out that markets, in fact, do trend, and provides a behavioral finance explanation for why. I agree with this.

    3.- “What is hard, is distinguishing trend following from technical analysis from momentum.” Why is this hard? I have no problem distinguishing trend following from “technical analysis.” Mike discusses it in the book. I would label anything predictive or “more art than science” TA and anything reactive, systematic, and testable as TF. Regarding momentum, I have no definition for this word, so I can’t compare it to anything. I don’t think the word “momentum” appears anywhere in Trend Following, so I find disingenuous for Merkel to introduce a concept, refuse to define it, and then use it as an alleged refutation of Covel’s thesis.

    4.- ” He draws on a series of investors that have done well in the past…” Yes, MC provides readers with accounts of individuals who have used trend following and achieved great success. What’s wrong with that? It certainly proves that it CAN work, if nothing else. Merkel then wonders about the legions that have tried TF and failed. OK, if they are, in fact, legion, where are they? How come I’ve never heard someone come forward and say, “I rigorously designed and tested a robust trend following strategy, implemented it methodically, and went bankrupt.” It would seem that finding this one person would invalidate the entire trend following hypothesis; given all the people who claim that trend following is junk science, why has this “trader X” never come forward? I HAVE heard people say that they were running a systematic portfolio, but couldn’t handle it emotionally/psychologically, but that is a different story (and one which MC addresses.) On the other hand, I know plenty of people who have gotten cleaned out attempting discretionary trading. How come top discretionary traders are always presented as geniuses and never “merely the lucky survivors from a huge pool” whereas top systematic traders always get the reverse treatment? (Especially given that top systematic traders usually have much longer track records?)

    5.- “Mean Reversion.” Question: why are the people who are so quick to doubt trend following the first ones to tell us that mean reversion is the real deal? Put differently: why are trends just illusions created by a perfectly random market, but mean reversion is an actual non-random property of markets? Were this the case, why has no one presented a systematic way to exploit the market’s alleged tendency to mean revert? (Why is there no Covel doppelganger out there writing a book called “Mean Reversion: Learn How Great Traders Make Millions in Choppy Markets”) Why are there no lengthy track records of people who trade exclusively mean reversion? Personally, I have no idea whether mean reversion is an actual, exploitable market property, but I think the above questions should be answered by anyone touting it.

    6.- “Not enough time spent on how to trend follow.” Probably the second most important point of trend following is that sticking to a systematic strategy is going to be difficult emotionally. (The number one point being that trends are a legitimate source of mathematical expectancy.) In order to execute, you are going to need extreme confidence in your methods. This confidence is best developed by designing and testing your own system. Were MC to provide readers with a simple system, he’d be opening himself up to a flood of angry emails (lawsuits?) etc. whenever the system experienced inevitable draw downs. He’d probably be doing many a disservice.

    OK, I’ve said my piece. I’ve skipped some of Merkel’s points, but I feel I’ve covered the major ones. I realize these are just the thoughts of one random, anonymous internet commentator, but I hope they provide some food for thought.

  26. Michael: As you know, I have been timing the market (trend following) for many years,and I know that 99.9% of investors do not know when the trend changes so they “Buy and Hold” and lose their shirts in Major Market Corrections. I guess that even though our mission is to help them, they can’t be helped. But we keep trying.

  27. David Merkel is Chief Economist and Director of Research for Finacorp. Your opinion regarding “paid professionals” is fair enough. I love dodgeball even though I was the little guy in 6th grade that always got drille din the head.

  28. Merkel seems to be concentrating his argument mainly on entry techniques.
    Trend following is a risk control system with specific position sizing algorithms which account for its success.
    The design of stops,scaling in and exits plus volatility factors are way more important than fundamentals or technical entry points.
    Its not about being right-its about winning-thats why Jim Simons has returned 50 times better than Buffett since 1987.
    Van Tharp through extensive research has found trend following to be the most successfull of all inestment styles.

  29. Sandy got a great point.. Everyone entitles to their own opinion but the market is always right. Personally, I had used fundamental approach, momentum, trend following(did’nt realised until I read the book in 2006). Whichever style that everyone has, utimately it will reflect in the result, profit or lost.
    I think trend-following do have better edge over long term as it fundamentally address the issue of individuals feelings when investing/trading/speculating whichever one would called it. Over the years, I’ve seen many people end up much poorer by not getting over their ego when they are investing/trading/speculating. This is especially true when we just went through a dramatic 2008.
    From public results, it seems that Trend-Following system(Super-fund eg.) did fantastically well last year. We can’t just solely rely on fundamental anaylsis to make our trading/investing/specualating decision. Trend-Following system should be incorporated as a major decision instead and refined to suits our individual styles. Utimately, the end results must be profitable. Michael, thanks for your great job! Keep it up…:)

  30. I guess there are a few key lessons from the rhetoric so far.

    1. More than one method can work, given different market consitions. Not just trend following.

    2. People have different techniques and exhibit cognitive bias in favour of their preferred technique.

    3. Survivorship bias will always cast doubt over the winners in trendfollowing, as has been pointed out numerous times above.

    4. Both Michael Covel and (in this case) David Merkel seem more intent on pushing their point of view on this enormously complex topic, rather than keeping an open mind and learning as much as possible from each other.

    I also echo the sentiments of Rob (comment14).
    That would seem a more effective way to educate the doubters, rather than spending hours posting blogs and replying to comments.
    It would be a much better use of time to trade one’s own advice and ‘walk the talk’.

    How about it Mr Covel?

  31. Karl I was waiting for a post like Cy’s (see above). There can’t be an honest debate when the other side doesn’t know what they are debating. Some people will see that as an accurate statement on my part and the folks who want dodgeball banned will see it as arrogance. Everyone sees and gets what they want out of this.

  32. I agree with the fact that Merkel’s review is full of assumptions, generalisations, opinion and cognitive bias.
    But, to be fair, your replies invariably display ‘all-or-nothing’ thinking and a ‘black-and-white’ worldview (with regard to trading methodology.

    It sometimes appears that it is ‘Michael Covel’s trend-following’ against the world!
    Is the world really divided into camps? OR is there more to it?

    Ultimately, Michael, the most effective defence in light of ALL the naysayers, doubters and plain fools would be to show your own trend following trading record.

    That would quiet the masses and lend more educational credence than anything said so far.

    How about it?

  33. I do not trade on behalf of clients, nor do I have any intent to do so. If/when I ever did I would meet all disclosures. That said, I trade my own account, make films, and write books. These comments have been posted more than once on this blog. Clearly, the subject of what trend following is has stopped from those still not getting it. Not surprisingly, once inaccuracies were pointed out from my vantage (and others like Cy’s), the naysayers don’t have much to say on the content of my book. If the best that can be thrown this way is “grow up”, “you are not a fund manager”, “momentum is the same as trend following”, etc. etc. — the topic is run its course until the next wayward comment.

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