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Risk, Reward and Uncertainty

Trend followers understand that life is a balance of risk and reward. If you want the big rewards, take the big risks. If you want average rewards and an average life, take average risks. Charles Sanford gave a commencement address that is timeless. It said in part:

“From an early age, we are all conditioned by our families, our schools, and virtually every other shaping force in our society to avoid risk. To take risks is inadvisable; to play it safe is the counsel we are accustomed both to receiving and to passing on. In the conventional wisdom, risk is asymmetrical: it has only one side, the bad side. In my experience—and all I presume to offer you today is observations drawn on my own experience, which is hardly the wisdom of the ages—in my experience, this conventional view of risk is shortsighted and often simply mistaken. My first observation is that successful people understand that risk, properly conceived, is often highly productive rather than something to avoid. They appreciate that risk is an advantage to be used rather than a pitfall to be skirted. Such people understand that taking calculated risks is quite different from being rash. This view of risk is not only unorthodox, it is paradoxical—the first of several paradoxes which I’m going to present to you today. This one might be encapsulated as follows: Playing it safe is dangerous. Far more often than you would realize, the real risk in life turns out to be the refusal to take a risk.”

Life is fraught with risk. There is no getting away from it. However we try to control the direction of our lives, there are times when we fail. Therefore, we might as well accept that life is a game of chance. If life is a game of chance, to one degree or another, we must be comfortable with assessing odds in the face of risk.

Ep. 217: Risk, Reward and The Process with Michael Covel on Trend Following Radio

Risk, Reward and The Process with Michael Covel on Trend Following Radio
Risk, Reward and The Process with Michael Covel on Trend Following Radio

Michael Covel received an email from Jonathan Garner about a blog post from Derek Hernquist titled “I Have No Idea What Tesla Is Worth, Do You?”. It linked to a CNBC interview with an analyst named Brian Shannon. Covel plays the CNBC clip and gives commentary at specific points. Covel shares the technical analysis viewpoint with Shannon, but disagrees when it comes to price targets. Covel also points out some terms that aren’t part of the vocabulary of a trend following trader. A pure, predictive technical analyst could go that direction, but that’s not trend following. Covel isn’t trying to slam Shannon, who is trying to fight the good fight from a price action perspective. Rather, Covel focuses on CNBC’s coverage and one particular talking head who has no idea about technical analysis. Covel points out that even if you’re a purely fundamental trader, you have to know what trend following is, what it does, and how it behaves. Covel focuses on price action and momentum, not Tesla’s latest announcement. Shannon concludes by talking about risk management, which Covel then discusses. Covel ruminates on why trend following and technical analysis are so confused, and talks about the difference between predictive and reactive technical analysis. Continuing on with another example, Covel tells a story about a young man he met who invested in $10,000 worth of Facebook stock, and why it’s important to have an exit plan. Covel was forwarded the young man’s blog post, which stated the decision to invest in Facebook was based off a wealthy friend’s advice. If you’re going to follow advice, make sure it isn’t made up out of thin air. If you’re going to follow a thought process about how money is made, you have to scientifically dig in and look at the process. If not, it’s just gambling. To close out, Covel talks about a piece he re-read from Malcolm Gladwell about how Nassim Taleb first met Victor Niederhoffer.

Listen to this episode:

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More on Malcolm Gladwell & Nassim Taleb can be found here.

Busted flat in Baton Rouge… waiting for a train

Not all trend followers are the same and not all stick to their rules.

A few years ago a young guy under the tutelage of a known and famed trend follower (not a Turtle in this example, but I know two Turtles who walked the plank so to speak) started a fund. He raised over several hundred million in assets under management. He was making good money, but the credit crisis started and for whatever reason this trader went from systematic trend following to discretionary day trading leaving fellow employees scratching their heads (can’t make this up). It did not end well. Firm is gone now. So what do we all do with this example? Is that a trend following failure or something else? Clearly, it is something else. I know quite a few examples like this. Do some money mangers get into trend following, raise $, get in over their head then start changing this or that because of some gut impulse… and go bust? Absolutely. Rules in this world are important.

Lessons? Manage risk, and the reward will follow. Ignore your process and that opening lyric from “Me and Bobby McGee”…will happen. In my book, there is as much to learn from the consistent trend following studs as there is to learn from the cons and quitters.

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