If you are browsing through this in a bookstore, you are most likely in the investments section. Look around. All of the people near you are also looking for an investing edge. If you are online, you can see by the ratings and recommendations that many other people have been here before you. The other titles in front of you, whether they are actual or virtual, all claim to represent an opportunity to enrich you. Whether you know it or not, you are in a market. You are looking for a winning trade — the information, the edge — that will put you ahead in the markets of stocks, bonds, real estate, or commodities.
When I first modeled the trading strategies of J. Peter Steidlmayer, CBOT trader and the originator of the Market Profile, I had a narrow notion of what makes a market, or how to make money in one. I had heard of George Soros, Jim Rogers, Peter Lynch, and a few others. When I heard the phrase, “buy low and sell high,” it made sense to me. It also happened to appeal to me as a former antiques dealer and all-round bargain hunter.
I didn’t know how little I knew. Somehow I traded my model of the Market Profile — despite my utter ignorance of risk and money management — into a tidy profit. A colleague pointed out to me, “So you’re betting on your opinion of other people’s opinions.” The reality of W.C. Fields’ famous retort to Mae Wests question (in My Little Chickade) sunk in. “Is poker a game of chance?” “Not the way I play it.” I was concerned only with market signals — I had a stretch of what you’ll learn was “Dumb Luck,” instead of the “Poetic Justice” usually dealt to traders with such a lack of preparation. I got out to trade another day.
My chapter in Jack Schwager’s The New Market Wizards made it possible for me to meet top traders across the industry. Sometimes we appeared on professional panels together. Other times, it was a private conversation. I want to share some of what I learned with you. Before I do, though, I want you to take out a dollar bill. Turn it over. You will see two seals. Look at the one on the left. The one with the words “THE GREAT SEAL” inscribed underneath it, the one with an unfinished pyramid of 13 steps with an eye in a glowing triangle floating above it. It is a wonderful symbol for a successful trader and represents a trading tool as well.
The stones of the pyramid represent the ways a trader can make money. There’s intermediation (brokerage charges), aggregating clients (reducing costs), carry trades, privileged information (insider trading), assessing asset flows (an institutional advantage), advanced technology (particularly for option pricing), models of economic actors and data (fundamentals), models of historical price data (technicals), and others. Some of these are basic — those near the base of the pyramid — and so they offer low returns. Other methods offer high returns. Naturally, as you make your way up on the pyramid, there are fewer stones. No one should be surprised by this. Neither was I.
What did surprise me when meeting and modeling these market wizards was that despite their outward, often dramatic, differences in trading and life style, their thinking about their trading principles was extremely similar. It was like they were floating above the world, seeing it from a different perspective than the rest of the market participants. What are these differences? Here are a few from the eye of the pyramid:
- It doesn’t matter what you think, it’s what the market does that matters.
- What matters can be measured, so keep refining your measurements.
- You don’t need to know when something will happen to know that it will.
- Successful trading is a probabilistic business, so plan accordingly.
- There is an edge to be gained in every aspect of your trading system.
- Everyone is fallible, even you, so your system must take this into account.
- Trading means losing as well as winning, something you must learn to live with.
Now, you might say to yourself, “Where’s the secret sauce in that?” In one sense, you’re right. These are extremely simple principles. At the same time they are counterintuitive and take a focused effort to apply. Let me give you an example: I was attending the trading system conference where I first met market wizard Ed Seykota. His table was talking about how successful trading systems could, and should, be simple enough that they could fit on a bumper sticker. Of course, skepticism emanated from other tables. “What about the complexities of the markets?” Their response was that they weren’t interested in the markets’ complexities; simply in making money on changes in price. Ed and his traders saw through the smokescreen of untested assumptions and beliefs about what you need to know about a market and what it takes to make a successful trading system. This is the difference between knowing a principle and making it’s market application. Think about adding to a position — also known as “pyramiding.” Adding less with each addition to a position actually creates more gain than adding equal amounts each time. It’s simple and it’s counterintuitive. Another way that image on the dollar is a trading tool.
The book you have in front of you bridges this gap between trading principles and their market application like no other. It may look like a book, but it is really a set of trading tools — a complete and detailed application of these principles and others to the method of trading known as Trend Following.
Author and trader Michael Covel has arranged these master lessons so that you can approach them according to your personal preference, or as they call them these days, biases.
The Personalities — In the chapters on great trend followers, you can read the personal histories of leading traders. You’ll find there isn’t just one type of successful personality; they range from college students to real scientists.
The Performance — For the factually minded, in the chapters on performance data and big events in trend following, there is a succinct summary of historical data from several trend following funds, along with parallel events in the world.
The Psychology — For those who think human behavior and decision making make the difference, there are chapters on each of these, as well as on emotional intelligence — and how to get it — followed by the dangers of Holy Grails.
The Trading Systems — The risk, the reward, the key questions to ask, and the questions Michael is most often asked, along with commentary from the master trend followers themselves, encompass these chapters.
The remarkable thing is not that you are looking at this book, but that it exists at all. Conventional wisdom says buy low and sell high. Each of us got our education in bargain hunting somewhere along the line. But what do you do now that your favorite market — be it a stock, bond, or commodity — is at an all-time high…or low? For a completely different perspective, from people who actually make money at this business, take a look inside. Michael Covel has written a timely and entertaining account of trend following — how it works, how to do it, and who can do it.