You Don’t Need to Understand Electricity to Use It

A Friday thought…

No one can predict a market trend, you can only react to them! Trend following never anticipates the beginning or end of a trend. It only acts when the trend changes. However, there is no need to figure out ‘why’ a market is trending — just follow it. You don’t need to understand electricity to use it.

19 thoughts on “You Don’t Need to Understand Electricity to Use It

  1. Mike, regarding the systems you include in your course, are they ready for one with a brokerage account to put into use immediately? Or does one still need to do some work, such as selecting markets, backtesting the system on those markets, or other required steps?

  2. With March Madness upon us, I’m thinking about how this system helps me find more “high-seed” stocks and avoid the “low seed” stocks. Yes, high-seeds get upset by lower-seeds, but over time, the high-seeds tend to win more often.

  3. IIRC, the turtles were given a fixed number of futures markets in which they could trade. They could choose any number of them, but must stick to the selection.

    For your systems, do you provide an initial list of markets from which the student can choose from, either choosing all or a subset?

  4. Selecting a portfolio is part of what we teach. We are clear about that.

    In terms of the Turtle days — 1984 to 88 — there are many more markets to trade today. There is even more opportunity. Use the Turtle experiment for many reasons (i.e. nurture beating nature, successful trend following example, etc.), but holding onto a market mix from 25 years ago is not recommended.

  5. It is a testament to the buy hold/mutual fund propaganda machine…that people look at TF with this cautious eye bordering on pathological skepticism, but at the same time will sit in mutual funds for decades taking on even more risk (read: they have been electrocuted more times than they can count!)…but never mention it or discuss it.

  6. Also, keep in mind, my analogy was really a stab at fundamental analysis — as a fundamentalist would say you need understand electricity to use it.

  7. I still think you need to understand why trend following works to use it (ie kurtosis of distributions, behavioral biases of investment herd)…

    Otherwise you might just end up stopping believing in it and giving up during the drawdown periods

    Fully random markets trend very well as well, however there is no way you can make a dime off them (making the “There will always be trends: you just have to follow them” argument a bit specious)

  8. true – I stayed attached to my initial feeling (clearly exhibiting anchoring bias) from reading your headline, expecting you to tell us “you dont need to understand why trend following works to use it”…

    I guess behavioral biases are everywhere 😉

    It is after all a good metaphor for Trend Followers’ attitude to taking trades…

  9. Jez, where are these fully random markets? I haven’t seen any. And even if they did exist, who says you can’t make money off them? If I remember correctly this was one of the questions Richard Dennis asked prospective Turtles, “can you make money in a random market?”. The correct answer was actually yes. Wherever there is a trend, there is money to be made.

  10. Jez> Even in a random market, there will be trends. They may at best be shorter in nature, but it cannot be without any trend.

  11. Jez Liberty Says: “Fully random markets trend very well as well, however there is no way you can make a dime off them (making the “There will always be trends: you just have to follow them” argument a bit specious)”

    Jez… now you’re just talking to hear yourself speak. What you said makes absolutely no sense.

    Whether you believe markets are random or not has nothing to do with it. If you admit that trends exist, then you can make money. I (and many others) make a nice living trading trends in many “random” markets. The fact that you may be predisposed to “give up” during a losing streak is an issue of trading psychology and/or money management, not of the trend following method of trading.

  12. Michael: I love your Friday thought. As you know, I am a market timer, or should I say Trend Follower. I have been identifying changes in the trend of the stock market in real-time for over 40 years. I never now how long a trend will last, but I go with ever trend. I never believed the statements like, “the markets look 6 months into the future”. And I do not listen to people who predict the future course of the market. I have only one question for the person who predicts where the market will be months in the future.
    My question to that person is “what is the market going to do tomorrow?” Ben Stine said it well when he was asked how the market would react after the health care vote on Sunday. He said that the market only gives us information one day at a time. He said,”The market is like a thermometer. It takes the temperature of investors only once a day”. Some think it would be great if we could look into the future. I do not. But I must confess, I have a crystal ball on my desk.

  13. @Ken, @Prashanth, @Trader Jim:

    Take a fair coin. Use it a your price generator/simulator (simplified example of fully random market generating +1%/-1% every day). When trends start to develop, follow the trends (choose any ones you want with any funky money management you like). Tell me if you make money (in the long run).

    You won’t (you will have some lucky periods followed by unlucky periods but a net return of Zero: its called mathematical expectancy). I am sure that even Mike would agree that Trend Following works for specific reasons (that he explains in his books: behavioral biases, etc.). These reasons generate a pattern in price data, which makes it diverge from the truly random/efficient model.

    @Ken: agree – I dont know of any of these fully/random markets (I was going to ask Trader Jim where he sees them since he supposedly makes money from them). I dont recall that quote from Dennis and dont believe its true (actually quickly checking Mike’s Turtle book I can not see any reference to that quote only one analogy between their trading and dice being non-random, ie Six-Six coming more often than expected). I might come across as pedantic but I am raising the point that Trend Following’s profitability is invertly linked to the underlying market’s efficiency/randomness (among other things). There is always the danger that markets become close enough to full random to make Trend Following not prrofitable enough (to cover trading costs or even be attractive enough).

    This is what I meant about your book making Trend Following sound simple: people end up believing the argument “As long as there will be trends…”

    PS: I would really like comment notifications on the blog

  14. Jez, the coin flip arugument is not a fair comparison. Why? because coin flips are independent mutually exclusive events. A coin has no memory. A coin is not a market. Markets are made up of people and people have memories. What you do today affects what you do tomorrow, what you did yesterday affected what you did today. What you do one nanosecond from now is partially determined by what you did one nanosecond ago. Human behavior is not random because humans have memory, a coin has no memory and so it is random.

    I’ve seen the list of questions that Dennis asked prospective Turtles. I don’t remember exactly where, maybe it was on this website or another website or in one of the turtle books, but it was somewhere. I remember being confused by that at first too but what I think Dennis really meant was can you make money in a market that seems random, that ends up where it started after some time period (like the US stock market in the last 10 yrs).

    There is always the danger that markets become close enough to full random to make Trend Following not prrofitable enough (to cover trading costs or even be attractive enough).

    I would agree with that.

  15. Ken

    I was using the coin flip analogy as a comparison to a fully efficient/random market. I believe that in a full random market, there is no memory, etc. This was a simplistic and extreme example to illustrate the fact that if markets are fully random: you cannot make money off them (I think we both agree on that point).

    Now: are markets fully random/efficient? I dont believe they are – mostly because of some of the aspects you mention. Which makes the EMH (Efficient Market Hypothesis) flawed.

    But I dont think this is a binary question: are markets random or not? There is a degree of randomness, which is probably linked to the level of eficiency in that market (I recommend reading Andrew Lo’s paper on the Adaptive Market Hypothesis AMH which is a good illustration of this concept and tries to reconcile the EMH with the behavioral biases that invalidate the EMH). In the AMH theory markets’ efficiency fluctuate based on the “ecology” in that market.

    To summarise a long argument, my point is:

    Even a non-fully random market can exhibit trends, yet Trend Following would not be profitable if applied to that market (if it has a high level of “efficiency”)

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