The Elliott Wave Principle posits that collective investor psychology, or crowd psychology, moves between optimism and pessimism in natural sequences. These mood swings create patterns evidenced in the price movements of markets at every degree of trend or time scale. In Elliott’s model, market prices alternate between an impulsive, or motive phase, and a corrective phase on all time scales of trend, as the illustration shows. Impulses are always subdivided into a set of 5 lower-degree waves, alternating again between motive and corrective character, so that waves 1, 3, and 5 are impulses, and waves 2 and 4 are smaller retraces of waves 1 and 3. Corrective waves subdivide into 3 smaller-degree waves starting with a five-wave counter-trend impulse, a retrace, and another impulse. In a bear market the dominant trend is downward, so the pattern is reversed—five waves down and three up. Motive waves always move with the trend, while corrective waves move against it. The patterns link to form five and three-wave structures which themselves underlie self-similar wave structures of increasing size or higher degree. Note the lowermost of the three idealized cycles. In the first small five-wave sequence, waves 1, 3 and 5 are motive, while waves 2 and 4 are corrective. This signals that the movement of the wave one degree higher is upward. It also signals the start of the first small three-wave corrective sequence. After the initial five waves up and three waves down, the sequence begins again and the self-similar fractal geometry begins to unfold according to the five and three-wave structure which it underlies one degree higher. The completed motive pattern includes 89 waves, followed by a completed corrective pattern of 55 waves. Each degree of a pattern in a financial market has a name. Practitioners use symbols for each wave to indicate both function and degree—numbers for motive waves, letters for corrective waves (shown in the highest of the three idealized series of wave structures or degrees). Degrees are relative; they are defined by form, not by absolute size or duration. Waves of the same degree may be of very different size and/or duration. The classification of a wave at any particular degree can vary, though practitioners generally agree on the standard order of degrees (approximate durations given):
-Grand supercycle: multi-century
-Supercycle: multi-decade (about 40–70 years)
-Cycle: one year to several years (or even several decades under an Elliott Extension)
-Primary: a few months to a couple of years
-Intermediate: weeks to months
Elliott Wave prose is almost as good as Scientology: Definitely No PhD Required.
Robert Carver got his start in finance working at trend following firm AHL in 2001 during his final year of college. He was introduced to quantitative trading while at AHL and for the first time began thinking of finance in a systematic way. He later went back to AHL, working there from 2006-2013. His newest book is “Smart Portfolios: A Practical guide to building and maintaining intelligent investment portfolios.”
It took a lot of research and digging for Robert to decipher which financial tools available to traders were appropriate for him. He knew he was not the only trader with this problem so he decided to write a book laying out what he had found through his research. Robert gives actionable tips and guidelines for others who may need help finding what trading instruments are right for them. Robert also wanted “Smart Portfolios” to be a book for the average investor. He wrote it in a way that is not over complicated. Any trader, new or professional, can pick it up and find it useful.
Robert bases portfolio selection around three questions: 1. What should you invest in? 2. How much of your capital goes into those investments? 3. Do you make changes to your portfolio along the way? Whenever he receives questions from people, those questions usually fall into one of the above categories. There is never perfection when trying to predict how a portfolio will perform but Robert stresses that if you start your investing answering the above questions, you will be on the right track. After the right portfolio and financial tools have been selected it’s necessary to understand different types of returns. Michael and Robert finish the podcast discussing differences between geometric and arithmetic returns.
In this episode of Trend Following Radio:
Warren Buffett trading
Expected average performance
Leveraging a portfolio
Luck vs. Skill
“Most people probably spend much less time thinking about their portfolio’s than they do thinking about getting their car fixed.” – Robert Carver
Art Collins is author of “Beating the Financial Futures Market: Combining Small Biases Into Powerful Money Making Strategies”, “When Supertraders Meet Kryptonite”, “Market Rap: The Odyssey of a Still-Struggling Commodity Trader” and “Market Beaters.” He has been trading systematically for the past 30 years.
How was Art Collins able to get Richard Dennis, Bill Dunn, Bob Pardo, Mike Dever and Larry Williams (to name a few) to talk? He made the interviews more like a partnership, than an interview. He made an impressive name for himself which led to positive word of mouth spreading.
What does robustness mean to Art? He uses four rules for prudent testing: 1. Don’t settle on your best result if it is a “diamond in the rough”. 2. Strategies should test well in various markets, particularly similar ones. 3. You don’t want your results to be bunched up in limited time frames. 4. Stay focused on testing concepts you understand in the markets.
Throughout the years Art wasn’t only focused on trading markets. He also studied how to beat the blackjack table and how to skew the odds in his favor when betting on sports. Trading football lines, and trading the price of stocks – what’s the difference? There isn’t much of a difference when you take a technical and systematic approach to them. It’s about keeping emotions out of it. He never wanted to be a cowboy trader or thought of as a “genius”, he just wanted his systems to work. Michael and Art spend the rest of this episode diving into card counting, mechanical systems, gambling on football, data mining and the fools errand of making $1,000 a day.
William Eckhardt, the great trend-following trader, has spoken forcefully about the idea of not having a memory in your trading:
“Suppose two traders, A and B, are alike in most respects except the amount of money they have. Suppose A has 10 per cent less money but he initiates a trade first. He gets in earlier than B does. By the time B puts the trade on, the two traders have exactly the same equity. The best course of action has to be the same for both of these traders now. Mind you, these traders have very different entry prices. What this means is that once an initiation is made, it does not matter at all for subsequent decisions what the entry price was. It does not matter. Once you have made an initiation, what your initiation price was has no relevance. The trader must literally trade as though he doesn’t know what his initiation price is.”
The firm’s chief researcher Robert Rotella will go back and look at the models to see whether there is anything unsound about the way they are programmed. Generally, there is not.
Next, a check is made to see whether there is a way to improve the model. Such improvements have to made with caution, he says, because the whole idea of being a systematic trader is to have robust systems in place that don’t have to be tweaked all the time.
The more a trader tinkers, the more he has to worry about curve fitting. While Rotella, an absolute disciple of robust models, doesn’t like to fiddle with its models, there is sometimes no choice if the market sends a message that losses continue even after delevering.
“Obviously you don’t want to overhaul a program in response to one year just because something didn’t work. That’s when you’re almost guaranteed that it would have worked the next year had you kept it in there.”
Our philosophy rests upon two main pillars. The first pillar is: macro, not micro. So we trade macro variables, not stocks and shares and credit default swaps and things like that. We trade across currencies, commodities, interest rates, bonds and equity indices. The second pillar is: a systematic approach, not a discretionary approach. So we describe our style as systematic global macro. Systematic trading involves coming up with a statistical model of the markets. Assuming that model has worked in the past, and that you have developed and researched and tested your model correctly, then your hypothesis is that it’s likely to keep working in the future. So the actual execution of trades is just continuing to follow what the model says. Now that sounds quite mechanical. In fact, it’s no different than the way any good investor works. Why would you invest with Warren Buffett? Because, over the past 30 years, Warren Buffett has made money, and you’re assuming that’s going to continue in the future. Conceptually, that’s no different than what we do.
When I use the term “scientist” to describe myself and my colleagues at Cantab, what I’m really talking about is a mindset. It’s a mindset of evidence based investing and using the scientific method to think about investing. The scientific method has worked pretty well for the human race for the last 2,000 years—it’s worked out better than superstition, anyway. And we believe in applying the same rigorous principles as in medicine or air traffic control. Everyone is quite happy with evidence-based medicine and air traffic control—would you fly in a plane controlled by someone who just had a gut feeling about where they wanted to go?
Michael starts an email from a listener that starts with praise, then turns around and claims that a top trend following trader has 400 employees and “super computers” to carry out trades, and that is why he is so successful. Michael uses this listener as just one example of how millions think. They are confused by what a computer does, and simply don’t understand what trend following is all about. The trader he refers to is on record saying that he trades off of Excel spreadsheets. For the remainder of the podcast, Michael expands on his response to the listeners email, and breaks apart algorithmic trading.
Michael next reads an excerpt from “Intuition Pumps and Other Tools for Thinking”, by Daniel Dennett. The excerpt breaks down algorithms in depth. Michael’s point is to show that a computer doesn’t make a great trader, it is the algorithms programed in the computer that creates the success. Where do the algorithms come from? Humans. Trend following is all about having the brilliance to come up with a strategy, but the execution is straightforward.
In this episode of Trend Following Radio:
Machines replacing humans
Breaking down the use of software
“…The power of computers owes nothing (save speed) to the causal peculiarities of electrons darting about on silicon chips…” – Daniel Dennett
“Trend following trader = CPA not AI singularity theorist.” – Michael Covel