I Never Promise Secrets: Trend Following is Hard Work

Pauline Skypala writes in FT.com “Secrets of winning systems remain hidden”:

Homespun investment wisdom does not come much cheesier than the Whipsaw Song, available on YouTube. Sung to a bluegrass tune, it imparts the trading philosophy of Ed Seykota, who is regularly described as a legendary trend-following trader. His advice is simple: ride your winners, cut your losses, manage your risk, use stops, stick to the system, file (ie, ignore) the news.

The same list could also be used to summarise the lessons Michael Covel seeks to teach in The Little Book of Trading: Trend Following Strategy for Big Winnings (John Wiley & Sons, 2011). But there is a caveat; it is not as easy as it might sound. In fact, the main insight Mr. Covel provides is that successful trading is hard won, and requires an entrepreneurial mindset, a fascination with numbers and charts, and discipline. A helping hand from a mentor such as Mr Seykota does not go amiss either.

Mr. Covel’s profiles of big name trend followers are more likely to persuade readers to hand over their money to these people than to attempt to emulate them. Retail investors “tend to blow up”, he says, because they lack the discipline to “stick with their system”. The most common mistake is a failure to cut losses–to let emotion interfere.

Clearly, traders need to believe in whatever system they devise so they can trust it sufficiently to leave it alone. Mr. Covel does not give anything away about the workings of the systems of the successful traders he writes about, such as Larry Hite, David Harding and Michael Clarke. He does not “reveal the secrets of trend following insiders” as is promised on the cover blurb.

Such information would doubtless be worth far more than the price of the book, but some of the reviewers on Amazon obviously felt short-changed by the lack of any discussion of trading strategies.

The book merely contains advice such as this: “Certain types of systems do perform better than others, and selecting certain clusters of variables within a system will affect system performance.” Then repetition of the point already made, that once established, a system must be followed religiously. Further, a system must work across all futures markets, over many types of market conditions and over many timeframes.

Such a system could take some time to perfect, but Mr. Covel reassures readers that they can operate it out of their bedroom. There is no need for a big office and an army of PhDs (unless you want to do very short term trading or “sophisticated PhD stuff”, which he does not define).

He advises that market selection is a crucial element in success. Any system would have made money in cotton, but none would have done so in cocoa, for example. “There’s a pervasive mindset that every market should be weighted equally. That’s not true,” he writes in the chapter on David Druz, who apparently learned this from Mr Seykota.

However, in a later chapter, Mr. Covel says one of the key realisations was “that risk management centered on trading markets equally, from a risk perspective, was mission critical. You just can’t favour one market over another.”

The first point is about portfolio selection, the second about risk management, so they are not as contradictory as they first appear. Presumably they are both factors that need to be built into a system.

But the rambling and repetitive nature of the book is unhelpful in tying such points together.

Mr. Covel is an evangelist for the trend following style of investment. He decries traditional investment approaches that rely on fundamental analysis, and says buy and hold investing via mutual funds will never make anyone rich. Selling trend-following courses is his business, so this is no surprise.

The apparent ability of trend following commodity trading advisers to make money when all others are losing it, as in 2008, has made investors sit up and take notice of this corner of the investment world. Mr. Covel’s book is timely in that respect.

But the idea that anyone with some skill in maths and computer programming can achieve similar results is fanciful. They may get lucky, but are more likely to get wiped out.

My first thought is courtesy of Seth Godin:

Stand out or fit in. Not all the time, and never at the same time, but it’s always a choice. Those that choose to fit in should expect to avoid criticism (and be ignored). Those that stand out should expect neither.

Thanks for paying attention. Now a dialogue can unfurl. You can find a little snippet of a response on today’s podcast too (first few minutes).

Note: I never promise secrets in my books, film or training. Trend following for those not yet familiar with it is all about gaining knowledge you might not have yet. Perhaps, that can be characterized as secrets by some, but it really comes down to hard work–why people pay me.

Recommended Reading and Listening

Entrepreneurship and Asymmetric Information

Possible Better Processes

Alexander Elder Podcast Interview

Podcast with Harry Silverglate

Interview with Art Collins

The Author