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?
Noted value investor Jeremy Grantham maps out why trend following wins (PDF) — which I am sure was not his intent. He seems to think like my style of trend trading, even though his way to get there is quite different.
Note: Shout to www.pragcap.com for finding the PDF.
“Those who do not think that employment is systemic slavery are either blind or employed.”
And:
“They think that intelligence is about noticing things that are relevant (detecting patterns); in a complex world, intelligence consists in ignoring things that are irrelevant (avoiding false patterns).”
BUY-AND-HOLD INVESTING is a loser, says Michael Covel, founder of Trend Following, one of several Websites devoted to the trading strategy of the same name.
“How many more decades can you go with negative returns?” he asks, referring to the disappointing aughts (www.trendfollowing.com). The unofficial chronicler of the 25-year-old active investing strategy, Covel claims that leading practitioners of trend following, like Boston Red Sox owner John William Henry, have collectively logged a 17.56% average annual return since 1984 compared with 7.37% for the Standard & Poor’s 500.
Trend following is grounded in the notion that a stock or sector in motion tends to stay in motion—until it stops. “Markets that break out are more likely to continue than to reverse direction,” maintains Covel. It’s equally applicable to short and long trades and to any class of asset—stocks, futures, currencies—with typical holding periods of a few weeks.
Trend following is similar to momentum investing, except that devotees studiously avoid using company fundamentals like revenue growth or positive earnings surprises as trade signals. The focus is entirely on price movement—although trend followers aren’t that enamored of charting or technical analysis, either. When a trend starts, most technical indicators turn in the same direction, says Covel.
THE KEY DIFFERENCE between trend following and most investment strategies is the lack of crystal-ball gazing. Trend followers make no attempt to forecast a trend’s duration, magnitude or key inflection points. Entry and exit triggers are decided at entry, and trend followers often arrive late to the party.
Its “buy high, sell higher” orientation smacks of the bigger-foolism that has tripped up so many investors, large and small. But trend followers don’t blindly chase bubbles. Their systems try to take the emotion out of investing through rules-based decisions, back-testing of trade theses and strict risk management.
A portfolio is usually spread across a dozen or more (hopefully) noncorrelated assets with tight trailing stops, which can be 2% or less below entry price. That means a high percentage of holdings can get stopped out in the search for a few home runs. Investors need a pre-defined fund allocation strategy that can withstand a losing streak.
“As many as 60% of initial bets will be wrong,” says Covel, “The biggest impediment to success is fear of failure.”
Jack Zaner wrote me today with a great quote from David Eckstein (2nd baseman for the San Diego Padres) about what it takes to play successful baseball in a pennant race:
“The ball doesn’t behave differently in September than it did in the spring. It moves no faster. It hops no harder. The trick is to stick to your routine in the face of accumulating anxiety; to play the game as if you were installing widgets on an assembly line. The game doesn’t change unless you allow it (to) in your mind.”
