My guest today is Jason Williams, M.D., a highly trained psychiatrist and the son of legendary trader Larry Williams, explains how to assess and measure your innate personality traits and align them with your trading style for more profitable trading on a more consistent basis.
The topic is his book The Mental Edge in Trading : Adapt Your Personality Traits and Control Your Emotions to Make Smarter Investments.
In this episode of Trend Following Radio we discuss:
Using your personality to your advantage
Psychology of trading
What is the NEO PI-R test?
Why anxiety is important in trading
Commonalities among traders
“The markets are very complex in understanding that nobody really understands how and why the markets move all the time.” – Dr. Jason Williams
Please enjoy my monologue Lessons Comparing Pro Football and Pro Baseball with Michael Covel on Trend Following Radio. This episode may also include great outside guests from my archive.
In this episode of Trend Following Radio:
The success of Larry Hite
Baseball vs. Football
Trusting the data
“If you don’t see the exercise in modesty, the honesty inside your own self, how will you ever get to the goal? We have one life, use it well.” – Michael Covel
Charles Faulkner has been featured in many Trend Following Radio episodes and across all of my books. An excerpt from “The Little Book of Trading”:
Perhaps you have heard the expression about living in the moment of now. What do I mean? The past is gone and the future is unknowable, but we have right now. That does not mean we cannot consider our past experiences or mistakes as useful references. Nor does that mean we cannot prepare and plan for the future. It does mean that making decisions based upon what is actually happening in the moment of right now is how great trend following traders organize their lives and produce their fortunes.
While not primarily a trader, Charles Faulkner brings a tremendously useful insight to the table. In all my years I can think of no one who does a better job of bringing traders and investors to a better understanding of themselves. Understanding yourself as a trader is the needed introduction to the journey of success in trend following profits.
Faulkner sees the world from a very wide and novel perspective, and you should too.
Case in point: A crucial lesson to understand is that when entering the market game, losses are part of the game. No matter the amount of experience you have, there will always be losses. That said, you want to make sure your losses are ones that you can handle—knowing that they are emotionally going to affect you.
People in sports understand this. Professional game players understand that to build your skill, you need to take losses and learn from them. You hope to play against people better than you because that is what makes you better.
Studying traders is very useful because everything in their world is extremely focused due to the intensity of their profession. What might take months or years to unfold in an ordinary life can unfold very quickly for traders.
For example, for many people the biggest purchase they make is a house or a car. And for many successful trend traders that kind of money can go through their hands within an hour, or even minutes.
This means, when trading, you don’t want to view money in terms of dollars as if you were going to buy a new car, but rather use the dollars to keep score. Putting yourself into that mental framework is critical. Releasing your mind from how you value money in terms of shopping, and instead focusing on it as a score during the game, is a huge first step.
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A nice email came across my desk:
Good day Michael,
First I want to thank you for sharing your work with me and the rest of the world. I first read your work about 5 years ago and have not missed a podcast. Many podcasts I have returned to repeatedly for the timeless information and thought-provoking content. Another resource I don’t miss is the Epsilon Theory notes by Ben Hunt (thanks for introducing me to his work as well). I just wanted to suggest to you if you have not already read Ben’s latest note “I know it was you, Fredo” it is worth the time, like all of his notes. The information you have shared has not only changed my approach to the market but to nearly every aspect of my life. The exposure you provided me to the works of Charles Faulkner and Alan Watts two examples of many that have shaped the way I think about the world.
I felt it was time I thanked for what your work has meant to me.
My guest today is Thomas Sterner, the founder and CEO of The Practicing Mind Institute. As a successful entrepreneur he is considered an expert in Present Moment Functioning or PMF tm. He is a popular and in demand speaker who works with high performance individuals including, athletes, industry groups and individuals, helping them to operate effectively within high stress situations so that they can break through to new levels of mastery. He self published the first edition of “The Practicing Mind,” and as it snowballed into a phenomenon, publishers started knocking at his door for wider distribution.
The topic is his book The Practicing Mind: Developing Focus and Discipline in Your Life Master Any Skill or Challenge by Learning to Love the Process.
In this episode of Trend Following Radio we discuss:
Attention combined with intention
Non-judgment
Perils of multitasking
Controlling your mind
Constant media chatter
“If your not in control of your thoughts, then you are not in control of yourself.” – Thomas Sterner
“All of life is practice in one form or another. Actively practicing something is very different from passively learning. You will never reach a level of performance that feels complete so learn to love the art of practicing your skill.” – Thomas Sterner
The turn of the year is when traditional long only money managers state their predictions for the year ahead. Equity managers may be bullish if stocks are cheap or central bankers are expected to flood the markets with money, for example. Or they may be bearish if value is perceived the other way. It may not be an easy task, but the manager can generally make a guess based on a reasonably sound and intuitive argument. For a trend follower, however, it really is hard to answer the question in a manner that would satisfy most people.
The reason for this originates in how trend followers trade…trend followers are typically long when a market is rising and typically short when a market is falling. This is achieved through a systematic, non-discretionary process where computer algorithms analyse historic data in order to identify trends lasting anything from a few days to multiple months, with an average of around two months. Of course, individual markets may not trend all the time, so trend followers diversify by trading a wide variety of markets over many asset classes. The intention is that, as long as these markets are lowly correlated, the trend-following net is cast as wide as possible, and trends are captured wherever and whenever they occur. The technique is applied to the most liquid instruments available, meaning the strategy itself is highly liquid.
So trend followers do not care whether markets go up or down as they can potentially profit either way. Trend followers do not care which markets trend, as they typically trade a range of asset classes. Trend followers do care about persistence. As long as trends last at least a couple of months, the typical holding period of a medium term trend follower, we are generally happy.
Our prediction for the year ahead is therefore based on the persistence of market moves, and what can give us any confidence in that? Quite a lot, as it turns out. First of all, there is theoretical grounding for the existence of trends through the field of behavioural finance, or because of the varying speeds of dissemination of information into markets for example. Second, and perhaps more persuasively, there is evidence of trends existing in markets for hundreds of years1. So although it may be difficult to think why trends may persist in the year ahead, history and theory are with you.
The differences in how traditional versus trend-following managers have to think about the year ahead is a manifestation of the different yet complementary approaches both take. As you might expect, different approaches lead to different return profiles.
…trend followers are typically uncorrelated to equities (and other asset classes for that matter) because trend followers can be long when prices rise and they can be short when prices fall. What is also clear is that when the S&P has its worst calendar years, trend following returns have tended to be strong. It would seem that when equity markets are in crisis, trends can be strong and trend followers can be profitable.
If you have been inundated with predictions from traditional managers for 2016, spare a thought for us non-traditional managers. We find it hard to give explicit catalysts for performance in the year ahead, and as such are reluctant to give forecasts…Trend following offers an uncorrelated return stream to equities, and can even perform strongly when equities are in crisis. Trend following is perhaps considered a non-traditional strategy but on these grounds it may well be a welcome addition to traditional portfolios.
A happy reminder of the efficacy of trend following.
Risk and volatility are two very different concepts:
Nicola Meaden, a hedge fund researcher, compared monthly standard deviations (volatility as measured from the mean) and semi-standard deviations (volatility measured on the downside only) and found that although trend followers arguably experience higher volatility, it is often concentrated on the upside (positive returns), not the downside (negative returns).
What does this mean? Trend following performance is unfairly penalized by performance measures such as the Sharpe ratio. The Sharpe ratio does not care whether volatility is on the plus or the minus side because it does not account for the difference between the standard deviation and the semi-standard deviation. The actual formula for calculating them is identical, with one exception, the semi-standard deviation looks only at observations below the mean. If the semi-standard deviation is lower than the standard deviation, the historical pull away from the mean has to be on the plus side. If it is higher, the pull away from the mean is on the minus side. Meaden points out the huge difference that puts trend following volatility on the upside if you compare monthly standard (12.51) and semi-standard (5.79) deviation.
Here is another way of thinking about upside volatility: Ponder a market that is going up. You enter at $100 and the market goes to $150. Then the market drops down to $125. Is that necessarily bad? No. Because after going from $100 to $150 and then dropping back to $125, the market might then zoom up to $175. This is upside volatility in action.
Trend followers have greater upside volatility and less downside volatility than traditional equity indices such as the S&P because they exit losing trades quickly with preset stop losses. This means they have many small loses as they constantly try to see if an entry into a market pans out into a big trend.
Michael Rulle, past-president of Graham Capital, helped to mitigate volatility fears:
“A trend follower achieves positive returns by correctly targeting market direction and minimizing the cost of this portfolio. Thus, while trend following is sometimes referred to as being ‘long volatility,’ trend followers technically do not trade volatility, although they often benefit from it.”11 The question, then, is not how to reduce volatility (you can’t control the market after all), but how to manage it through proper position sizing or money management.
Bottom line, you have to get used to riding the bucking bronco. Great trend traders don’t see straight up equity curves in their accounts, so you are in good company when it comes to the up and down nature of making money.
John W. Henry made the clear distinction between volatility and risk:
“…Risk is very different from volatility. A lot of people believe there is no difference, but there’s a huge difference and I can spend an hour on that topic. Suffice it to say that we embrace both volatility and risk and, for us, risk is that we’re going to lose if we risk two tenths of one percent on a particular trade. That is, to us, real risk. Giving back a profit to you probably seems like risk, to us it seems like volatility.”
Henry’s long-term world-view didn’t avoid high volatility. The last thing he wanted to experience was volatility that forced him out of a major trend before he could make big profits. Dinesh Desai, a trend follower from the 1980s, was fond of saying that he loved volatility. Being on the right side of a volatile market was the source of his profits.
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Feedback from a listener who gets it:
Greetings Mr. Covel,
During your recent interview with Didier Sornette, you mentioned that you consider risk to be the maximum amount of capital that you can lose. Similar to you, I studied finance in a university and I always disliked the idea that the volatility of an asset’s price is its risk. Perhaps you can produce a podcast discussing the pros and cons of various measures of financial risk. Academia has convinced vast cohorts of students to believe that the historical volatility of an asset’s price is its risk.
Regards,
[Name]
Spot on. How much can you afford to lose? That’s risk.
Please enjoy my monologue The Force Awakens with Michael Covel on Trend Following Radio. This episode may also include great outside guests from my archive.
