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Volatility as the Measure of Risk; Not Wise

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Greetings Mr. Covel,

During one of your recent podcasts, you and Wesley Gray were discussing how the academic community considers the volatility of an asset’s price to be its risk while you and Gray consider the permanent loss of the capital invested in an asset to be its risk. Many years ago, I read an interview of Harry Markowitz where he stated that he used volatility to measure the risk of an asset because “it made the math easy.” I was completely shocked. The father of Modern Portfolio Theory chose his measure of risk based on its mathematical convenience.

I searched for the interview again because I wanted to send a link of it to you so that you could read it for yourself. Unfortunately, I could not find the interview but I still remember the feeling of complete shock that I felt when I read that Markowitz chose volatility as the measure of risk because “it made the math easy.”

What is your understanding of how volatility became the primary measure of risk in finance?

Regards,
[Name]

I don’t believe Markowitz believed that as you state, but rather was designing for theory. As you might recall he was surprised that modern finance was built off his work. He wrote the PhD paper, and others extrapolated his work into something else. Markowitz, himself, stated that “semi-variance is the more plausible measure of risk.”

But I have also see this:

“I would’ve created CAPM around semi-variance, but no one would have understood the math and I wouldn’t have won Nobel Prize…” –Harry Markowitz

Harry Markowitz
Harry Markowitz

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“Given that you’re taking a risk, what kind are you up for?”

Great post by Seth Godin:

Here’s an interesting choice that most people leave unmade:

How comfortable are you engaging in projects where there’s a likelihood that you’ll lose by just a hair?

What makes a project worthwhile and interesting is that it might not work. All the this-is-sure-to-work projects are taken.

Given that you’re taking a risk, what kind are you up for?

Are you seeking out areas where there’s no competition, true longshots where few people see you fail?

Or are you okay with the daring near misses?

That’s the trend following ethos too.

Risk
Risk

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Trend Following Podcast Guests
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Performance
Research
Markets to Trade
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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.

Life as a Continuum Running on Loop Back and Forth from Risk to Reward

Life is a series of bets. Decisions on top of decisions. Choosing a trading strategy is one of those decisions to bet on. Consider an excerpt from Trend Commandments:

You want to see life as a continuum running on a loop back and forth from risk to reward. If you want a big reward, take a big risk. If you want an average reward and an average life, take an average risk. Easier said than done, however, if you want the big reward. Our system is notorious for playing Whac-A-Mole with achievers. From an early age, people are conditioned by families, schools, and virtually every other shaping force in society to avoid risk. To take risks is inadvisable; to play it safe is the message. Risk can only be bad. However, winners understand risk is highly productive, and not something to avoid. Taking calculated risks is different from acting rashly. Playing it safe is the true danger. Far more often than you might realize, the real risk in life turns out to be the refusal to take a risk. If life is a game of risk, then to one degree or another, being comfortable with assessing odds is the only option for a fulfilling life. Consider trading from a “startup” business perspective. Every business is ultimately involved in assessing risk. Putting capital to work to make it grow is the goal. In that sense, all business is the same. The right decisions lead to success, and wrong ones lead to insolvency.

Blunt, but true.

Now, feedback from a listener that made the right bet:

Trend following has indeed changed my life. After a 20-year career on Wall Street I am now a successful, profitable, independent trader. Have I made money with trend following? Yes, indeed. Living a nice life in Chicago with three kids going to private school, enjoying the finer things. My strategy is not difficult to execute at all. Very basic and straight forward. I keep it as simple as possible. I will absolutely continue to execute this strategy. Mind you–always looking at new information and ideas.

Thanks!


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Also jump in:

Trend Following Podcast Guests
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Performance
Research
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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. 388: Logic Over Faith with Michael Covel on Trend Following Radio

Logic Over Faith with Michael Covel on Trend Following Radio
Logic Over Faith with Michael Covel on Trend Following Radio

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Please enjoy my monologue Logic Over Faith 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:

  • Logic over faith
  • Financial advisors: there to give mutual fund advice
  • Adapting your strategy
  • How quitting can keep you in the game
  • Forcing yourself to make decisions
  • Risk and reward

“What I say is, at what price? If low interest rates were just that simple of a panacea, we would never have recessions. We would never have these crises, we would never have these panics.” – Carl Icahn

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Ep. 387: Gabriel Weinberg Interview with Michael Covel on Trend Following Radio

Gabriel Weinberg
Gabriel Weinberg

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My guest today is Gabriel Weinberg, the CEO and Founder of DuckDuckGo, a search engine. What sets DuckDuckGo apart from other search engines is the privacy that it guarantees its users. DuckDuckGo promises to never track a user’s clicks, or use previous searchers to aid current results. Since creating it 11 years ago, his engine has reached 30 million searches a day in 2018, up 50% from a year before, and is poised to grow even faster since Google added DuckDuckGo as a default search-engine option in its latest Chrome browser in more than 60 markets in March 2019.

The topic is startup entrepreneur.

In this episode of Trend Following Radio we discuss:

  • Reaching your goal, then setting another
  • Resilience: vital to the entrepreneur
  • Committing to your idea
  • Psychology: the main barrier to success
  • Understanding that it’s okay to fail
  • Enjoy the challenge – or go do something else

“And so if you think of your initial product as a leaky bucket – you know, you pour in customers at the top and customers leak out of the bucket because your product’s not good yet…You need a steady stream of cold customers with fresh eyes to tell you where those leaks are, and if you don’t have that when you launch you’re still gonna have leaks more of the time than not.” – Gabriel Weinberg

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Ep. 386: Expanding Your Thinking with Michael Covel on Trend Following Radio

Expanding Your Thinking with Michael Covel on Trend Following Radio
Expanding Your Thinking with Michael Covel on Trend Following Radio

Subscribe to Trend Following Radio on iTunes

Please enjoy my monologue Expanding Your Thinking 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:

  • Why embracing uncertainty pays big
  • Trend following: it’s human nature
  • Losses: acceptable when you strategize to cover them
  • The sunk cost fallacy
  • Opening your mind to alternative ways of thinking
  • The mistake of blindly accepting the word of “authorities”

“I remind you there is a new kind of special occupation. I refuse to call it a discipline or a field of study. It’s called futurism. The notion here is that there is a way to study trends and know what the future holds. That would indeed be valuable if it were possible. But it isn’t possible. Futurists don’t know any more about the future than you or I. Read their magazines from a couple years ago and you’ll see an endless parade of error.” – Michael Crichton

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Want to learn more Trend Following? Watch my video here.

Get the foundation to making money in up, down and *surprise markets on the Trend Following mailing list.

Ep. 385: Paul Slovic Interview with Michael Covel on Trend Following Radio

Paul Slovic Interview with Michael Covel on Trend Following Radio
Paul Slovic

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My guest today is Paul Slovic, a professor of psychology at the University of Oregon and the president of Decision Research. Decision Research is a collection of scientists from all over the nation and in other countries that study decision-making in times when risks are involved. He study the psychology of risk and decision making. Current interests are motivating action to prevent genocides and nuclear war.

The topic is his paper Perception of Risk.

In this episode of Trend Following Radio we discuss:

  • The psychometric paradigm of risk perception
  • Balancing risk vs. reward
  • The concept of affect heuristics
  • How the media sways the public’s risk assessment
  • Fast vs. slow thinking
  • Risk in the context of decision making

“Bad is stronger than good. If something goes wrong in a system it decreases our trust in the management of that system more than when something goes right. Something goes right, it doesn’t really boost our trust and confidence. It’s the negative that outweighs the positive, and the negative is being conveyed to us much more frequently and forcefully through the media than the positive is.” – Paul Slovic

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