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Falling Prey to The Wall Street Journal Spin

Received this request recently:

Hello, I would like to know your view on this article by John Taylor.

Thanks for the opportunity to clarify:

1. In my 4 books I address multiple historical instances where trend following was pronounced “dead”.

2. Trend following is not meant to be a currency only strategy. Diversification is mission critical.

3. Some trend following performance for comparison: Please keep eyes wide open to a longer time horizon v. the short-term focus of a WSJ reporter spin pen.

4. Taylor sounds as if he is using fundamentals to explain trend following strategy. Trend following is a systematic technical strategy. There is no fundamental usage.

Ep. 46: Ralph Vince Interview with Michael Covel on Trend Following Radio

Ralph Vince
Ralph Vince

Michael Covel speaks with Ralph Vince. If you’ve done your homework on trading systems, specifically about optimal bet sizes, you have run across Vince’s work before. Vince is self-taught and has crafted some extremely detailed, comprehensive looks at optimal betting strategy for traders over the last 20-plus years. Covel discusses whether coming up outside of the typical educational institutions affected Vince’s outlook – and how learning outside of institutions can work better for some than others. Covel and Vince also discuss optimal bet sizes; whether Ed Thorp’s work and the Kelly criteria had any effect on Vince’s work; the importance of knowing the optimal spot depending on your criteria; why maximizing profits can result in a large drawdown – and why you should be happy about that; if diversification really does give you a free lunch; and the importance of learning the wrong approach.

Listen to this episode:

Trend Following Does Not Involve Prediction

John Thomas, The Mad Hedge Fund Trader, writes:

Fundamental researchers are asserting that at $100 per share in earnings, generating a price earnings multiple of 11.5, stocks are at the historical bottom of a 10-22  range. Q3 earnings are imminent, and will outperform on the upside, although not with the magnitude seen in recent quarters. Plus, QE3 is on the table, and the Federal Reserve may deliver a surprise at its upcoming September 20-21 meeting.

Furthermore, risk assets are about to enter a period of seasonal strength. If you “sell in May and go away”, you should then “return in September and buy.”

No, no, cry the technicians. The S&P 500 is in an ABC corrective pattern. Wave 4 is complete, and the beginning of wave 5 is imminent, crashing the market to new lows. This argument is most clearly elicited by my friend, Arthur Hill, at in the space below. He sees a downside target of 1,025, the July 2010 low.

What is a befuddled individual investor to make of all this? My belief is that fundamentals always win out over the long term, and that technical cues are at best, a lagging indicator. I use technicals for guidelines on where to place orders on a short term basis. The longer you stretch out your time frame, the less relevant they become.

At best, technicals are right 50% of the time, right in the same league as a coin toss. How many technical analysis hedge funds are out there? None. They are all fundamentally driven.

Trend followers are technical traders. How are those left out John? Wow. He continues:

The same technicians making the incredibly bearish prognostications today were making equally convincing bullish arguments in July.

However, since we are descended from prehistoric hunter gatherers, we are all visually oriented. We respond to stimuli we can see much more rapidly than those we can conceive. A picture truly is worth 1,000 words. And probably a lot more. That’s why so many brokerage firms use them to sell research. I employ charts to back up my fundamental arguments because they are so easy to understand, definitely not the other way around.

So I think the fundamentals will eventually win out, and that we will get the autumn rally that I have been predicting. Exactly when will that happen? Don’t ask me. Go ask a technician.

Trend following is not fundamental trading. It is not predictive technical trading. Trend following is technical trading, but it reacts to market moves over trying to predict them. That is a massive distinction. Few seem to see that clearly.

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