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Category: Black Swan Thinking

The Median Isn’t the Message by Stephen Jay Gould

Posted on by Michael Covel

A nice reminder from a great thinker:

If a little learning could ever be a dangerous thing, I had encountered a classic example. Attitude clearly matters in fighting cancer. We don’t know why (from my old-style materialistic perspective, I suspect that mental states feed back upon the immune system). But match people with the same cancer for age, class, health, socioeconomic status, and, in general, those with positive attitudes, with a strong will and purpose for living, with commitment to struggle, with an active response to aiding their own treatment and not just a passive acceptance of anything doctors say, tend to live longer. A few months later I asked Sir Peter Medawar, my personal scientific guru and a Nobelist in immunology, what the best prescription for success against cancer might be. “A sanguine personality,” he replied. Fortunately (since one can’t reconstruct oneself at short notice and for a definite purpose), I am, if anything, even-tempered and confident in just this manner.

Hence the dilemma for humane doctors: since attitude matters so critically, should such a sombre conclusion be advertised, especially since few people have sufficient understanding of statistics to evaluate what the statements really mean? From years of experience with the small-scale evolution of Bahamian land snails treated quantitatively, I have developed this technical knowledge – and I am convinced that it played a major role in saving my life. Knowledge is indeed power, in Bacon’s proverb.

A passage for trend followers? Hmmm… lion or gazelle.

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“Torturing the Data” Is the Siren Scream of a Coming Looter

Posted on by Michael Covel

Fred Munger once said:

“If you torture data sufficiently, it will confess to almost anything.”

When you hear market cons talking of data mining, endless optimization, & torturing data, etc., check to see if your wallet is still around. Good trend following trading systems fit like a loose mitten, not a tight glove.

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“Play Calling Is About Probability, Not Certainty”

Posted on by Michael Covel

Take two traders who win 40 percent of the time with their winners being three times as large as their losers. One has a history of 1,000 trades and the other has a history of 10 trades. Who has a better chance in the next 10 trades to have only 10 percent of their total trades end up winners instead of the typical 40 percent? The one with the 10–trade history has the better chance. Why? The more trades in a history, the greater the probability of averages holding true. The fewer trades, the greater the probability of moving away from the average.

Consider a friend who receives a stock tip, makes some quick money, and tells everyone about it. There is a big problem with this scenario. His population of winning tips is extremely small–one to be exact. That’s statistically insignificant. He could just as easily follow his next hot tip and lose all of his money. One tip means nothing. The sample is essentially anecdotal evidence.

Thinking in terms of statistics is everywhere if you are observant. During a Monday Night Football game, one of the announcers, Ron Jaworski, put numbers and odds in perspective for playing the game of football: “Play calling is about probability, not certainty.”

It is the same in trend following trading.

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Striking Out Is Part of Winning

Posted on by Michael Covel

I put this great quote in my bestseller Trend Following:

“What is striking is that the leading thinkers across varied fields–including horse betting, casino gambling, and investing–all emphasize the same point. We call it the Babe Ruth effect: even though Ruth struck out a lot, he was one of baseball’s greatest hitters.”

You have to get it–to survive. Ever hear political leaders talk like this? No, political leaders promote the nonsense that there will never be a stubbed toe again. Believe that?

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Understanding Your Relationship to Risk: Rolling the Dice and Loss Aversion

Posted on by Michael Covel

Stephen Horan writes:

Everywhere we turn, psychological tests are available to help us better understand ourselves and our own behavior. But often these tests fail to shed light on a person’s relationship to risk, particularly the risk of losing money.

That’s why I like to do my own thought experiment. When I speak to groups, I often ask the participants to consider the following scenario:

Suppose you are sitting in a captivating presentation and someone comes in and locks the door. Then the person announces that everyone in the room is free to leave under two circumstances. You can leave if you pay a $1,000 fee (à la Hotel California) or you can leave after flipping a coin and going double or nothing. If the coin turns up heads, you exit for free; if it’s tails, you pay $2,000.

On a consistent basis, some 80 to 85% of the people in the room choose to flip the coin. The results are always very biased toward flipping, and that says something about the human tendency toward loss aversion.

The classical theory of the rational, economic man would have him avoid risk and thereby avoid the coin flip. The difference in this case, however, is the negative expected returns (a loss of $1,000 in each case since with option B you have a 50% chance of paying $2,000).

Since negative returns are at play, a loss aversion mechanism kicks in, and people will actually go double or nothing in order to keep from losing—thereby taking more risk.

The first reaction I get is surprise from people who otherwise think they make “rational” decisions regarding money. They realize for the first time the innate nature of loss aversion. That’s why I put the term “rational” in quotes. People are not necessarily “irrational” or stupid on this point; they are simply being human.

That thinking is foundational to becoming a successful trend following trader.

Note: Shout to Alistair Evans for the hat tip.

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Trigger Your Thinking: Jim Simons

Posted on by Michael Covel

An excerpt from: The Secret World of Jim Simons by Hal Lux:

Like all quantitative money managers, Renaissance aims to find small market anomalies and inefficiencies that can support profitable trading on billions of dollars of capital. Though all quant shops are alike in their dedication to models Let the best algorithm win! Renaissance’s approach differs from the “convergence trading” popularized by John Meriwether’s Long-Term Capital Management and similar arbitrage shops. Convergence traders price financial instruments based on complex mathematical models, find two different instruments that are cheap and expensive on a relative basis and then buy one and sell the other, betting that the prices will, at some point, have to return to their proper level. The Renaissance approach requires that trades pay off in a limited, specified time frame. And Renaissance traders never override the models. Back in action, Medallion made its mark through rapid, short-term trading across futures markets. “I have one guy who has a Ph.D. in finance. We don’t hire people from business schools. We don’t hire people from Wall Street,” says Simons. “We hire people who have done good science.” “We have three criteria,” says Simons. “If it’s publicly traded, liquid and amenable to modeling, we trade it.” Unusual for a hedge fund, the heart of Renaissance is not its trading room an uncluttered room where a score of traders buy and sell around the clock but rather an auditorium with exposed beams that seats 100 and features biweekly science lectures. Last month a molecular biologist presented research on colon cancer. “When you hear someone talk about an interesting use of statistics it helps trigger your thinking,” says one Renaissance employee.

I remember a few years ago, sitting in the private office of one of the best trend following traders around (performance and assets), talking about this very issue with him: how does Simons really trade?

He was not buying the ‘short term’ public facade.

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Sports Betting: Billy Walters the Trend Follower

Posted on by Michael Covel

Insights on Billy Walters:

As a society we have been conditioned to believe that there is a difference between gambling and investing. Of course, this partially true, however, the degree to which we “invest” and “gamble” is smaller than most are likely comfortable admitting. The majority of us have been conditioned to believe that buying a share of Bank of America is vastly different from placing a bet at a roulette table. A closer inspection of “investing” and “gambling” shows that the two are closer than the Wall Street sales machine would like you to believe.

60 Minutes aired an excellent piece this past Sunday about Billy Walters (video attached below). Walters is a Las Vegas gambler widely acknowledged as one of the greatest gamblers Vegas has ever seen. He’s so good that he has to bet anonymously through partners due to the fact that most casinos won’t take the other side of a bet from Walters. The few casinos that do bet with Walters do so mainly because they want to know what he’s thinking. But Walters isn’t truly a gambler. Walters is so good that he feels safer gambling than investing. And ironically, it isn’t the casinos in Vegas that have taken Walters for a ride over the years, but Wall Street. Walters claims that it is not Vegas where the thieves live, but rather the men in suits on Wall Street.

Before we can understand the difference between gambling and investing it’s best to define each. Gambling is placing capital at risk of loss with an uncertain outcome in a system in which the odds are generally unfavorable. Gambling has an inherently negative connotation because it is generally a term used to describe games in which the player is a guaranteed loser over the course of the game’s lifetime. Unlike investing in equities, a bet at a casino generally has unfavorable odds. The game is intentionally devised as such. Investing, on the other hand, is placing capital at risk of loss with an uncertain outcome in a system in which the odds are generally favorable. The primary difference between gambling and investing is the determinability of the outcome. The lottery for instance, is entirely unpredictable. Purchasing government bonds has a high level of predictability. Read the rest of the article.

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How can you move forward immediately to Trend Following profits? My books and my Flagship Course and Systems are trusted options by clients in 70+ countries.

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Trend Following is for beginners, students and pros in all countries. This is not day trading 5-minute bars, prediction or analyzing fundamentals–it’s Trend Following.