The Need to Try and Explain

This excerpt from the wires today is interesting:

A stock bounce was hardly unexpected, though, after the Dow lost nearly 240 points Monday on worries about the sagging financial sector. Wall Street is torn: Energy prices, if they continue on their downward path, could provide big relief to consumers and in turn help the economy, but credit losses keep mounting at the nation’s major banks. The result is big swings in the market but little consistent direction. “We’re living from one piece of news to the next,” said Alan Gayle, senior investment strategist for RidgeWorth Capital Management. The market’s volatility is likely to continue unless it gets further evidence that oil prices are, indeed, on their way down, and that banks have already seen the bulk of their losses.

That poor reporter. He has to write something. He has to try and paint word pictures to explain volatility, but it is clearly a struggle for him. I am not sure how a reporter can wake up excited each day to go to a job that requires him to literally make stuff up to justify random price movements.

16 thoughts on “The Need to Try and Explain

  1. Are you excited to get up everyday to read their work and critize it? Which, essentially seems to be your work on this blog…

  2. oh, you moderate postings…

    never mind. why would you ever post something critical about YOUR work…

  3. I agree with you, Michael, that reporters often have to find reasons to explain the movement of stocks, or other financial instruments. And, more often than not, those statements are made up.

    Is it really the case that on one random day 1000 investors get up and think today they are going to worry about inflation and what Ben Helicopter says – or are most of them actually sticking to a trading plan (i.e. trendfollowers, algorithmic traders, etc.)

    Well, probably the latter. We, as traders, dont get up in the morning and start to worry about the stuff they told us we did worry about all day at night.

    However, I would not disagree with the fact that volatility is high due to uncertainty with energy prices. Higher oil prices means higher prices of production and transportation for companies. And it means less free money for households – at least for the ones that own a car or two, or use electricity.

    That energy shock has led to a secondary downtrend. Some might call it a bear market. And, as we all know, prices fall harder and faster than they rise. Which equals higher volatility.

    So, as long as energy is in a bull market it is likely that the volatility in equities stays high….

    well, I just dont think that this stuff is entirley made up. Unless you think the market is totally random – which of course would neglect trendfollowing…

    so, which side are you on?

  4. 1.) Why is it unimportant for trendfollowers to think about volatility?

    2.) How did this blog post help me as a trader?

    3.) What are markets for you? Random? Or Trendy?

    4.) Are markets always trendy? or always random?

    5.) how do you derive that I have no understanding of trend following? i have read both of your books. (Not saying that I find them to be essential reading)

    6.) What information is helpful for traders in your eyes? And why dont you blog about that?

  5. Joe, as I mentioned earlier, this is not the place for rants, raves and apparently now threats (”I will make your online life hell now.”) As most people know I do write books. I am also finishing production on a film documentary. I also trade my own account, but I am not a hedge fund manager acting on behalf of clients. That is not my calling.

    In terms of your questions, clearly volatility is an issue for trend followers. Are markets random or trendy? In all of the conversations I have had with some of the best traders on the planet I don’t remember that question being on the table. I am not sure I even understand what the definition of “trendy” even is. I guess it can mean many things to many people. When I think about the 5 questions I pose that make up a trend following system…determining whether a market is trendy or not is not on the short list to dos.

    In terms of information I consider helpful, I consider the issues and topics I write about helpful. Thousands upon thousands of people agree, perhaps you don’t. Fine by me, but this blog as I said before is not the place for your conspiracy theories.

  6. Not sure if I should actually reply to this, but what the hell….

    Markets are both random and trendy. To demonstrate this, take a very simple model and assume the same amount of movement each day (let’s say 1%) and you have a 55% chance of being up and a 45% chance of being down on a given day, then you would expect in the long run to make money being on the long side – it’s a trend on the long side. The problem is that you do not know which 55% are going to end up and which 45% are going to end down. For example consider you are flipping a coin and it lands heads up 5 times in a row. This is an unusual event, but not so unusual that you would not expect to see it and it does not mean that over the long term you would see pretty close to a 50/50 split. So with the above model, seeing a week of down days is going to be about the same odds, unusual but not impossible. This is the issue with trend following, how do you know if the trend has ended or you are simply experiencing one of these unusual events?

    To demonstrate what I mean, lets say that the underlying probabilities in our model shift to 45% up 55% down, then you will see a trend reversal, but you do not know this until after the fact. You can only tell this when you have enough evidence to show that this is now the most likely event rather than a freak set of occurrences like our 5 heads in a row. Sure, it may be that we have simply hit a long run of down days and the underlying probability is still 55% up, but if the evidence points to a trend reversal you get out as this is the most likely event.

    The system you build should find these points when the most likely event is a reversal and tell you to get out/go short. If these decision points make you more money than they lose (in percentage terms) then they are ‘right’ even if an individual decision they make is ‘wrong’.

    Volatile markets have larger intraday changes in prices, so the signals that tell you this information get buried under the noise of the volatility. Think of a radio signal, the more white-noise you put over it the harder it is to work out what the guy is saying – volatility has the same effect on a trend following system, it makes it harder to ‘hear’ whether you have a trend or not.

    Volatile markets also mean that an up day or down day can lose you far more than the 1% mentioned for the model earlier, this means you must take smaller positions to keep your equity at risk the same as during lower volatility periods. So yes, volatility matters as it determines your position sizes and the amount of data you need to accurately ascertain whether a trend is present or not.

    What doesn’t matter is why the volatility happens unless you can determine this in such a way that will give you an edge in the market. The way this was reported gave you no information that could give you an edge in the market – wait until there is more evidence of oil prices continuing downward or the banks have stopped losing money…how can you tell? What is the evidence that this has happened? As it stands it is like me saying ‘it will rain sometime’ – I will be right at some point, but it doesn’t tell you whether or not you need an umbrella.

  7. Joe I think the point is that any explanation is incomplete since their are too many variables to count on. I believe you state that since oil prices and energy prices have increased, it has led to a “Secondary” downtrend? what is this? you go on

    “…That energy shock has led to a secondary downtrend. Some might call it a bear market. And, as we all know, prices fall harder and faster than they rise. Which equals higher volatility.

    So, as long as energy is in a bull market it is likely that the volatility in equities stays high…”

    so you conclude that a bear market, created by the “energy shock”, equates to higher volatility, and follow that up with a bull market has higher volatility as well. So is it safe to say that volatility exists in a bear market and a bull market? What made you think volatility never existed before? Perhaps I am presenting a scare-crow, but what are you getting at here?

  8. Volatility or no valatility market trends can be identified mathematically. But only after the trend has started. So the mathematics measures and waits until it clearly identifies the trend change.

  9. I am observing that Joe seems to be very angry about ‘something’. Not sure what exactly, or what it was he was trying to achieve.

    Joe,some advice: Perhaps start your own blog and work out your frustrations there?

    After all, this is the blog of Michael Covel. If you don’t like his (often uncannily accurate) observation of the finance industry, then feel free not to read here.

    It seems so simple, doesn’t it?

  10. Back to the original issue: “The need to try and explain”.

    I have a question Michael. How would a trend follower write a daily market wrap-up or a general market update? Could you please give a short fictive example, many thnx.

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