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Category: Trading 101

Great Teachers that Shape My World

Posted on by Michael Covel
Great Teacher: Alan Watts
Great Teacher: Alan Watts

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.

—

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.

Best regards
[Name]

Welcome!

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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.

Ep. 398: Investing and Sports Parallels with Michael Covel on Trend Following Radio

Posted on by Michael Covel
Investing and Sports Parallels with Michael Covel on Trend Following Radio
Investing and Sports Parallels with Michael Covel on Trend Following Radio

Subscribe to Trend Following Radio on iTunes

Please enjoy my monologue Investing and Sports Parallels 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:

  • Consistency vs. the home run
  • Quarterly performance
  • Trend following performance
  • Emotion in human nature
  • Irrationality in investing

“The market is made up of people and to beat it you have to know them as well as you know the thing you are considering investing in.” – Howard Marks

“The future ain’t what it use to be” – Yogi Berra

“Consistency and minimization of error has always ranked high among my priorities and they still do.” – Howard Marks

Mentions & Resources:

Listen to this episode:

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Human Behavior: Core to Trend Following

Posted on by Michael Covel
Calm
Calm

Consider an excerpt from Trend Following:

Perhaps not surprising, trend followers have spent as much time observing and understanding human behavior as they have trading. Understanding human behavior and how it relates with markets is commonly referred to as behavioral finance.

Behavioral finance evolved out of a contradiction between classical economic theory and reality. Economic theory is based on the assumption that people act rationally, have identical values and access to information, and use rational decision making. The truth is people are irrational and seldom make completely rational decisions even if they think they do. I have had the good fortune to learn from some of the top minds in the field of behavioral finance. From Nobel Prize winner Vernon Smith to Charles Faulkner, my eyes have been opened. Faulkner outlined the core issues:

“The current proliferation of electronic technologies— computers, the Internet, cell phones, 24-hour news, and instant analysis—tend to distract us from the essentially human nature of markets. Greed, hope, fear, and denial, herd behavior, impulsiveness, and impatience with process (‘Are we there yet?’) are still around, and if anything, more intensely so. Few people have absorbed the hard neuroscience research that reasons arrive afterwards. That given the choice between a simple, easy-to-understand explanation that works and a difficult one that doesn’t, people tend to pick the latter. People would rather have any story about how a series of price changes happened than that there is no rational reason for it. Confusing hindsight with foresight and complexity with insight are a few more ‘cognitive illusions’ of Behavioral Finance.”

Faulkner is correct, but that doesn’t make his words easy. The problem is that by not accepting that truth, you will get into trouble one way or another, as Carl Sagan reminds us:

“It is far better to grasp the universe as it really is than to persist in delusion, however satisfying and reassuring.”

A few years after writing Trend Following I came across another great mind in the field of human behavior and psychology, Alan Watts. Consider some feedback from a listener:

Mike,

Thanks for turning me on to Alan Watts through your podcasts. Below is a link to an audiobook that I think you may find interesting, considering your interests in yoga and other eastern traditions. Andrew is a Lama (not a llama) and an old friend of mine: Here

Enjoy!
[Name]

Thanks!

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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• Frequently Asked Questions
• Performance
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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.

Quick Trend Following Q&A: Price and Volume

Posted on by Michael Covel
Michael Covel on iTunes
Michael Covel on iTunes

Price is key when trading. Consider from, Trend Commandments:

Tell me something the “market” does not know. The idea that you can know enough about Apple, oil, GE, and gold to trade them all the same way may seem preposterous, but think about what they all have in common: Price.

Market price is objective data. You can look at individual price histories, without knowing which market is which, and still trade all successfully. That is not what they teach at Harvard, Wharton, Kellogg, Stern, Darden, or pick your favorite business school du jour.

However, the concept of price as the critical trading cue may be too simple for mass acceptance. For example, a prominent business anchor opined: “At some point, investing is an act of faith. If you can’t believe the numbers, annual reports, etc., what numbers can you believe?” A longtime financial reporter at Fortune magazine was also on the highway going the wrong direction: “If some of the smartest people on Wall Street can’t trust the numbers, you wonder who can trust the numbers.”

You can never trust those numbers—that is, the reported firm details—completely. Someone can always alter them (remember Enron had a fake trading floor). Beyond that, even if you know accurate balance sheet numbers, how does this help you determine when or how much to buy or sell?

The market is always right, and price is the only true reality in trading. If you want to make money in any market, you need to mirror what the market is doing. If the market is going down and you are long, the market is right and you are wrong. If the market is going up and you are short, the market is right and you are wrong. Other things being equal, the longer you stay right with the market, the more money you will make. The longer you stay wrong with the market, the more money you will lose.

You do not need to know anything about bonds. You do not need to understand different currencies. They are just numbers. Corn is a little different than bonds, but not different enough to trade them differently. Some people have a different system for each market. That is absurd. You are trading mob psychology. You are not trading corn, soybeans, or S&P’s. You are merely trading numbers.

Some feedback from a listener on price:

Dear Michael, I think that you have done a great work in explaining what trend following is. However, there are two great arguments that you have never faced:

1. You have always discussed price. I know that prices constitute a trend. Nevertheless, you should interview some of the main traders that [use] volumes. I would like to know how great traders interpret volumes as they are the first step for an incoming new trend. This study is lacking in all your work. It would be very helpful to know anything about that.

2. You have always talked about trends. It is correct. However, it is better to buy a stock that is likely to have a +200% uptrend than a stock that is only likely to have a +20% uptrend. So the questions is: how do great trend follower traders make their picks by relying their choice ONLY on prices and volumes?

I will wait for a polite answer of yours.

Kind regards,
[Name]

You can’t predict the next 20% v. 200% move. Impossible.

Volume? That is not the main topic of conversation in my trend following world.

Good place to start: Read (PDF).

More to read.

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.

Overpopulation: A Trend Following Debate

Posted on by Michael Covel

When asked about trend following becoming “overpopulated” a Richard Dennis quote is often best:

“I don’t think trading strategies are as vulnerable to not working if people know about them, as most traders believe. If what you are doing is right, it will work even if people have a general idea about it. I always say you could publish rules in a newspaper and no one would follow them. The key is consistency and discipline.”

Psychology and following the rules are paramount–bottom line. Consider more from an excerpt from The Complete Turtle Trader:

The techniques that Dennis and Eckhardt taught the Turtles were different from Dennis’s seasonal spread techniques from his early floor days. The Turtles were trained to be trend-following traders. In a nutshell, that meant that they needed a “trend” to make money. Trend followers always wait for a market to move; then they follow it. Capturing the majority of a trend, up or down, for profit is the goal.

The Turtles were trained this way because by 1983, Dennis knew the things that worked best were “rules”: “The majority of the other things that didn’t work were judgments. It seemed that the better part of the whole thing was rules. You can’t wake up in the morning and say, ‘I want to have an intuition about a market.’ You’re going to have way too many judgments.”

While Dennis knew exactly where the sweet spot was for making big money, he often fumbled his own trading with too many discretionary judgments. Looking back, he blamed his pit experience, saying, “People trading in the pit are very bad systems traders generally. They learn different things. They react to the [price] ‘tick’ in your face.”

Feedback from a listener that addresses Richard Dennis:

Hi Michael,

Hope you are doing well. Again, I appreciate everything, specially your commitment to the trend following podcast. In a recent back to back [other podcast] between [name] and [name] they address an important question:

—

Q: What lessons do you take from the fall of Richard Dennis? One of the biggest swingers at the Board of Trade…great trader…not only that but he believed he could replicate trading skills and did so successfully. He trained a whole generation of people who came up [and] manged billions…and then he basically goes and explodes. What is the practical lesson for your audience here?

A: Speaking to the trend following school in particular (and various trend followers who blew up or bled out): I do believe that certain trading styles and methodologies can suffer greatly from overpopularity. When there are too many people following a widespread strategy, and not enough differentiation among that active group, the strategy can be degraded to the point of no longer working.

—

Personally, I don´t agree with that argument because market trends have been persistent over time. As Howard Marks said: “We don´t have to worry about everybody becoming to prudent or to wise, because we are talking about human nature.”

I would appreciate your insight on this argument.

Peace,
[Name]

I don’t see any argument. My views on this are answered across 2 books comprehensively (the question above has some inaccuracies for starters):

1: The Complete TurtleTrader
2: Trend Following

My best response is in about 180,000 combined words (that is not a dodge; reality is that my answer is long). And yes I talk about the good and bad of Richard Dennis, but the good far outweighed the bad.

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.

Also jump in:

• Trend Following Podcast Guests
• Frequently Asked Questions
• Performance
• Research
• Markets to Trade
• Crisis Times
• Trading Technology
• About Us

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.

My Thoughts on Gaining Quick Riches from Day and Short Term Trading

Posted on by Michael Covel

Consider an excerpt from Trend Following:

When you trade more or with higher frequency, the profit that you can earn per trade decreases, whereas your transaction costs stay the same. This is not a winning strategy. Yet, traders still believe that short-term trading is less risky. Short-term trading, by definition, is not less risky, as evidenced by the catastrophic blowout of Victor Niederhoffer and Long Term Capital Management (LTCM). Do some short-term traders excel? Yes. However, think about the likes of whom you might be competing with when you are trading short term. Professional short-term traders, such as Jim Simons, have hundreds of staffers working as a team 24/7. They are playing for keeps, looking to eat your lunch in the zero-sum world. You don’t stand a chance.

Unfortunately, the flaws in day trading are often invisible to those who must know better. Sumner Redstone, CEO of Viacom, was interviewed recently and talked of constantly watching Viacom’s stock price, hour after hour, day after day. Although Redstone is a brilliant entrepreneur and has built one of the great media companies of our time, his obsession with following his company’s share price is not a good example to follow. Redstone might feel his company is undervalued, but staring at the screen will not boost his share price.

The logic is clear. However, emails still arrive:

Listener: Good morning. I am fairly knowledgeable about Trend Following as a result of reading some of your books. My current plan is to successfully and consistently day trade the e-Mini S&P, then take those profits and learn Trend Following via your course and then successfully trade that way as well. So for the past almost 6 months I have been studying, following and recording daily price action and trading the S&P futures with varying degrees of success and failure. I believe that I am poised for a major breakthrough in my trading plan. As a result of hundreds of hours of studying and recording I have noticed some correlations of overnight price activity with daily price activity, price movement that is inter-related and occurs on a regular basis. To me, these are identifiable events (patterns) on the charts that reveal the “invisible hands” that influence and drive market activity, and perhaps tip off their thinking of where they are going to move the market to. I am now able to use this information on a small scale to take profits out of the market, and continue to make excellent progress. However, I still can’t pinpoint exactly how to use this information on a larger scale to make profitable trading decisions . I have an idea of how to conduct a study to determine if indeed this realization can or cannot be used to make consistently profitable trading decisions, but am not very sure if it would be correct or the best way to conduct a study. I would like to enlist the services of an individual who is well-versed in these types of studies using statistics, probabilities, time and percentages to determine possible outcomes. For example, if I see that a certain overnight price action occurred and it was inter-related with yesterday’s activity and/or recent overnight prices in a certain way, then what are the percentages/probability that today’s activity will be X. As I said earlier, I have recorded these relationships for just shy of 6 months now and suspect there is a way to use this information to make profitable trading decisions, but I’m not quite sure. So, my question for you is can you recommend anybody who you know that has the skill set to do this type of study, and may consider helping me make this determination? Of course I understand that there would be fair compensation for this service. I have already reached out to [name] but have not received a response, so I thought this may be a better way to go. I’ve also been to the Mathematics department at Ohio State University searching for help there, but to no avail. Please let me know what your thoughts are, and thank you very much for your time and for reading this.

Covel: Just to clarify you are asking only about short term S&P trading? To be direct: I have zero leads to help you on that front. I counsel all to avoid day trading. Feel free to follow up.

Listener: Understood. Yes, I am in an S&P trade for 2-3 minutes on average, 12-15 trades per day on average. This is due to the minimal margin requirements, only $500 per contract. It is definitely a very difficult type of trading, but I am using it to be able to afford to Trend Trade. I have been blessed to be shown a system that works which I discovered through much charting and effort. I call it RcS MP for “Reversal continuation System using Magnet Prices”. There is price action that occurs regularly that is “hidden in plain sight”. For instance, look at the 1 minute chart on the left in my attachment. From 1111 to 1122 the price action is a high possibility indication that prices will go down. I drew the grey lines (ON50%- 73, etc.) on the chart at about 730AM, and 4 hours later it is telling me that there’s a good chance of prices going down. They hit the ONT2a- 70 exactly, then went down to within .75 pt to the ONT3- 66.75. Short 2 contracts from 72 to 70, short 2 contracts from 72 to 68 equals 12 pts total, $600. It happens over and over again all week long. I’m looking for help to verify whether or not certain correlations can give me a high probability of larger profits in a longer time frame. Anyway, please do not share this with anybody. I appreciate your time, thank you again.

Covel: From a past thread: Ed Seykota on short-term trading.

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.

Also jump in:

• Trend Following Podcast Guests
• Frequently Asked Questions
• Performance
• Research
• Markets to Trade
• Crisis Times
• Trading Technology
• About Us

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.

The Annie Duke Episode: Poker and Trend Following

Posted on by Michael Covel

There are many correlations between trading and poker. Consider this excerpt from my best selling, Trend Following:

In the book Absolute Returns, Alexander Ineichen stresses that trading is a “game.” He sees no rules for the game except the constant of change, but more importantly, he reminds us that it is crucial to avoid becoming the “game.” There are three types of players in the game:

• Those who know they are in the game.
• Those who don’t know they are in the game.
• Those who don’t know they are in the game and have become the game.

If, within a half of an hour of playing poker (or trading for that matter), you don’t know who the patsy is, you’re the patsy, or as Ineichen calls it “the game.” I have introduced those traders who didn’t know they were in the game and therefore became the game in the big events of the Long Term Capital Management hedge fund implosion, the Barings Bank collapse, and the October 2008 market crash. I introduced those traders and investors who did not know they were in the game pursuing Holy Grails that never panned out. And I introduced trend followers who knew they were in a game and brought an edge to the table every time they played. If you know trading is a game and you want to be a part of it, these are stark choices.

—

Recently I had Annie Duke on my podcast. She is an author, entrepreneur and professional poker player. We discussed several ways in which the psychology of gambling overlaps with that of trading, investment and other aspects of business. The following is brief feedback from that interview:

Mike, loved, loved, loved the Annie Duke episode. My favorite one yet. GREAT STUFF! [Name]

Thanks! More on gaming and betting? Go.

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.

Also jump in:

• Trend Following Podcast Guests
• Frequently Asked Questions
• Performance
• Research
• Markets to Trade
• Crisis Times
• Trading Technology
• About Us

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.