An interesting exchange about trend following trading.
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Victor Niederhoffer: A View on Trend Following
Ed Thorp: Beat the Dealer’s Lessons for Trading
An excerpt from the La Times:
In a foreword to the book, statistician Nassim Nicholas Taleb (“The Black Swan”) boils down Thorp’s technique to the search for and capture of a “clear edge.”
That’s the quest that first got Thorp interested in blackjack. Living on a teaching assistant’s stipend from UCLA and following a cheap newlyweds’ vacation in Las Vegas with his wife, Vivian, he pondered the traditional assumption that in gambling, the house always has the edge.
“I had heard that winning systems were supposed to be impossible,” he writes. “I didn’t know why.” What he discovered was that the odds in blackjack change based on which cards remain in the deck after the others are played. Tracking the remaining cards would enable a player to determine when the odds are most favorable and exploit the advantage by raising the bet. Following a series of computer simulations, Thorp codified his findings into a paper on blackjack strategy for an American Mathematical Society conference in Washington.
He expected to be addressing a meager audience of academics. Instead, he found himself in front of a standing-room-only crowd in which “scattered among the mathematicians were others sporting sunglasses, gaudy oversized pinkie rings and cigars, as well as reporters with cameras and notepads.”
Ed Thorp in Time (PDF).
Play for Position, Not Performance, in Your Portfolio
Jonathan Hoenig makes some interesting points here. An excerpt:
“…most of the artistic world is subjective. One person’s trash is another’s treasure. But trading is just the opposite – it’s unabashedly objective. Numbers don’t lie. You’re either in the black or not. We’ve often pointed out that the only reason to invest in anything is to make money. Talk is cheap and performance is the only thing that really matters. So it might surprise you that, on a daily basis, I don’t keep precise tabs on my fund’s monthly or year-to-date performance. At any given moment, I’ll have a general estimate of where I stand, but as a rule I try and tune out the exact score. Why? If performance is all that matters, why would I avoid following the exact return? The answer is because trading is like chess, not weightlifting. It’s not an endeavor that’s won or lost in one day depending how hard you flex your financial muscles. It’s a finesse game; it’s strategy. So you think and play for position, looking to set up exposures that are likely to unfold slowly over the next six months…not 60 seconds.”
Turtle Casting Call: What Do You Know?
A few months back I announced my new upcoming book on the Turtles. The book is in the publishing edit process, but it was a conversation I had today that prompted me to write this unusual post.
What happened? I spoke with a trend following trader today. Due to a non-typical career path, he has had a very quiet and successful career over the last twenty years. How successful? He has earned himself a fortune close to $100 million dollars. Frankly, I felt stupid to not have heard of him! In conversation, he suddenly offered a Turtle connection. While he had no association with Dennis or the Turtles in developing his trend trading method (Donchian influences), he did receive advice from a Turtle early in his career about how to setup his trading firm (dealing with legal, etc.). It was the kind of nugget that just continues to make the Turtle story, with all of its tentacles, such a small world story. I KNOW this trader is not the only one with interesting experiences with Turtles over the years.
What does this mean for readers of my blog? Well, the randomness of today’s conversation got me to thinking that I should be asking EVERYONE if they might have a FIRST HAND anecdote or story about the Turtles in some way or another that would be interesting. I am interested in your small bits to big stories. If you do have one, contact me ASAP. There is no guarantee that your story will make it into my Turtle book, but if it is good, now is the time to contact me. DEADLINE? Now.
Mental and financial Aspects of Trading: A Story from a Bold Trader
A story from an old bold trader:
Hi Michael-I guess in this business there’s a story a day if you don’t live in a cave. Yesterday I had a visitor who wanted to come by and get my input on his trading. As you might imagine his trading has gone very poorly since his “advisors” have been quite negative on the US stock market and he continues to fight the existing trend which as of today at 2:00PM CST remains UP! He had heard through a mutual friend that I traded the S&P 500 Futures so perhaps I could give him some insight on what the market was GOING to do in the future. I quickly told him I had no clue whatsoever what the market was going to do and I learned long ago my opinions run from “wrong” to “really wrong”. I went on to tell him my trading decisions revolved around what the market is doing now as well as what it has been doing recently i.e. “what’s the trend?” Now I must confess as I have admitted to numerous times before I am not a long-term trend follower in the purest sense BUT I do trade with the trend be it up down or whatever. I have addressed that with you before. Anyway yesterday morning my plan for the day was to observe the S&P early in the day and watch for possible set-ups given my personal rules of engagement. Yes I approach trading on some level as a military exercise. I explained to my visitor that the S&P daily degree was still in an uptrend and my method always traded with the trend but I employ the shorter time frames to place my bets. This fits my personality as well as my tolerance for pain if you will. Sometimes I can tell you within 60 seconds if I have a good trade. Long Term Trend Followers can do the same thing but for them the confirmation of a good trade might take a few days but those who read this know what I mean. Sometimes you just know! On the alleged S&P mini crash of early yesterday-CNBC’s definition not mine a set up presented itself in the Hourly Time Frame that gave me a go. I went to my trading platform and left clicked twice and I was in. My visitor suddenly got that “deer in the headlight look” and asked me what I had just done. I said I just bought five contracts of the S&P 500. I then very quickly entered my protective stop and looked at my visitor and said, “Now where were we?” He kind of babbled something about DAY TRADING was a losing cause which I totally agree with for MOST traders but not ALL traders. I asked him if he had a written plan and if so was one of his goals to follow his plan in his trading. He told me he gave up on written rules because he had so many rules they were confusing him. I have been there and done that. I asked him how much he risked on each bet as a % of his trading equity as well as how much of his universe of investable assets he had committed to trading. This time his eyes began to glaze over and I feared he might faint. After maybe 45 minutes the market had spurted to the upside and I calmly and without saying a word sold my position with a decent profit of say a 2-1 risk vs. reward. The second reason I sold was the FED was meeting and my PLAN was to be out of the financial related markets prior to 1:00PM period no matter what I THOUGHT might happen. My new friend said, “How you do that?” I said I had a plan formulated that as luck would have it worked this time with a witness. They don’t all work that way but if 50% of ’em do I have a good life! He then asked me about my rules and my “system”. I told him I did not have time yesterday but if he would come over Saturday I would go through what I do. He seemed very excited but then I had to throw in the caveat to my offer. I explained to him the pain and suffering I had gone through both mentally and financially to get where I have been the last couple of years. Some call it “Up Down Up Down”. I told him what I did was ME and not HIM. I told him if he needed some help finding his ME I could refer him to some people who helped me three short years ago. This man has a law degree from Harvard along with a Masters degree in Tax Law. He is truly brilliant and he can’t trade a lick. You see intelligence has its downside in investing. The young student you quoted has a professor that emphasizes my point. Although politically incorrect I wish you a Very Merry Christmas and a Very Happy and Safe New Year! Semper FI!, XXX
Thanks.
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Michael Gibbons on “Trend”
Michael Gibbons of Gibbons’ Trading LLC provides good insight on “trend”:
“The reality is, most hedge funds make money on the long side of the market. That is, to get and maintain their clientele, they must focus on long only trades. To attract clients, they generally must claim they are fundamentalists, as technical analysis (specifically market timing) is out of favor at the moment. Now trading the long side of the market based on fundamentals (whatever they are), is still premised on the existence of a trend. That is, since the trend is the basis of all profit, the market has to be moving in your direction to make a profit. If you buy at A and sell at B, and the trade was profitable, the market went up-or trended (at least for as long as you were in the trade). Very few people can correctly define trend; I will do that here: it is something that repeats. So funds that trade the long side of the market, still require the existence of a trend to make a profit. Therefore, all those that would deny that they are trend followers are in fact, trend followers. They may not be consciously aware of it, but metaphysically, they are relying on the presence of trends to make money. Their methodologies may not be trend following algorithms, but nonetheless, they are in bed with true trend followers-even if they are not aware of it. The directional movement of a market determines dollar profit. If the S&P 500 goes from 1000 to 1500 and we are long, we make 500 points of profit less fees. The move from 1000 to 1500 was something that repeated-the S&P kept going up. The directional movement was up caused by the presence of a trend. Therefore, any attempt to deny that the trend is the basis of all profit, is a logical contradiction. True trend followers eliminate the rationalizations-they just admit they need trending markets to make money, and act accordingly.”
Mark Shore White Paper on Skew: Key Trend Following Insights
I had the opportunity to meet Mark Shore last spring in New York City at a presentation. His paper on ‘Skew’ (PDF) will be of interest to many readers:
Skewness relates to the symmetrical characteristics of the return distribution. Returns shifted towards the right (left), create positive (negative) skewness causing asymmetrical returns. When considering components of a portfolio, one must consider the co-skewness of each component. What is the result of the portfolio’s skewness when a new asset is introduced into the portfolio?
Shore also appears on my podcast.