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How to Start in Trend Following

Feedback in:

Hi Michael,

I’m a huge fan of your podcasts and have finished your books Trend Following, Little Book of Trading and Trend Commandments. I also listen to your podcast pretty religiously and am working through your early episodes with the fund managers. I’m currently in medical school living off loans so I use the public library for books whenever possible. I’m using just 50 day and 200 day moving averages and reading some of [name] works now. Do you have any advice on sources and ideas for trading systems and rules? Or any advice on the application of trend following.

Sincerely,
[Name]

Here is one way to start and another way to start.

Social Security Drama; It Never Dies!

Consider an excerpt from Trend Commandments [Update: Audio book now available!]:


Social Security is dead? Easier said than done.

On Meet the Press, one United States governor appeared confused: “If you care about democracy and what the everyday citizen believes, and you want to empower them, they don’t want the Social Security system to be dismantled, and they don’t want the Medicare system to be dismantled… this is a compact between generations to be able to make sure that all of our seniors have the funds when they retire, that they’re not going to be homeless, so they’re not going to have to go to a shelter.”

Did she know that the inflation adjusted return of Social Security is just 2 percent? A United States Senator on Meet the Press apparently did not: “Social Security is a program that works. It is fully funded for the next 40 years. Stop picking on Social Security. It’s not a crisis. Social Security is fine.”

Those politicians are not stupid; rather, they have ceased to think. Or, do they just need to tell a certain story to ensure power for whatever party with which they are affiliated? Waiting or hoping for your politician, on the right or the left or anywhere in between, to win an election is an investment strategy of your ignorance.

Behind the scenes and in the halls of Congress; drunks, perverts, and losers addicted to fame and power. Both sides. You can’t make money from them or social security. There are other options.

Process v. Outcome
Process v. Outcome

Twisting the Data: The Fed, Correlations and Intoxication

It is amazing how quick people are to forget how wrong one prediction is, only to move onto believing in another prediction. An excerpt from the chapter “Intoxication”, in Trend Commandments:

A bipolar prediction came across my desk recently: “If the market rises over the next several weeks, today will have been a good day to buy. However, no one can know the answer today. Every day there seems to be a surprise. We don’t know how to predict the behavior of foreign countries or their attacks.”

The nonsense doesn’t stop there. While on the East Coast recently, I was listening to an AM radio finance show. An older man called in to ask how he could buy into various commodity markets. He was worried that they had run too far already. The female host assured him that there was plenty of time and to jump into the market. The caller mentioned that he liked to buy low and was waiting for a pullback. The host told him to start preparing for hyperinflation. She named an African country to enhance her theory and leaned the conversation toward food insurance, needed of course for the coming descent into anarchy.

Think not knowing what you are talking about is new? Think again. President Herbert Hoover circa May 1930: “While the crash only took place six months ago, I am convinced we have now passed through the worst—and with continued unity of effort we shall rapidly recover. There has been no significant bank or industrial failure. That danger, too, is safely behind us.” Can’t just pick on old-timers. Consider the current day. Lloyd Blankfein (head of Goldman Sachs) said his firm would have survived the credit crisis without government help. The firm’s president, Gary Cohn, was more definitive: “I think we would not have failed. We had cash.” Treasury Secretary Timothy Geithner countered, “None of them would have survived” without government help.

More contradicting rhetoric from a 2010 60 Minutes interview reinforces the propaganda spell cast:

Scott Pelley: “Is keeping inflation in check less of a priority for the Federal Reserve now?”

Ben Bernanke: “No, absolutely not. What we’re trying to do is achieve a balance. We’ve been very, very clear that we will not allow inflation to rise above two percent or less.”

Pelley: “Can you act quickly enough to prevent inflation from getting out of control?”

Bernanke: “We could raise interest rates in 15 minutes if we have to. So, there really is no problem with raising rates, tightening monetary policy, slowing the economy, reducing inflation, at the appropriate time. Now, that time is not now.”

Pelley: “You have what degree of confidence in your ability to control this?”

Bernanke: “One hundred percent.”

That confidence seems misplaced when you consider Bernanke’s words but a few years before:

In 2005, Bernanke said: “We’ve never had a decline in house prices on a nationwide basis. So, what I think is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don’t think it’s going to drive the economy too far from its full employment path, though.”4 In 2006, Bernanke said: “Housing markets are cooling a bit. Our expectation is that the decline in activity or the slowing in activity will be moderate, that house prices will probably continue to rise.”

In 2007, Bernanke stated: “At this juncture…the impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained.”

Worse yet? Bernanke told the Senate Banking Committee in March 2011 that he saw “little evidence” that the stock market was a bubble, but provided certainty with this ditty of a response: “Of course, nobody can know for sure.” Why again do we care what this man says?

Not only can the pros not understand the data, but the conclusions they draw are almost always wrong.

Feedback in that adds to my thought:

Hi Mike, thought you might enjoy these. I listen to some of the BBC “More or less” podcasts, found this one (spurious correlations) when scrolling through their archives. So many out there (not just in finance) tend to torture data to find what supports their bias. The podcast and site do a good job at poking some fun at those tendencies.

Thanks!

For the audience:

Podcast “More or less: Behind the stats”: http://www.bbc.co.uk/programmes/p0201hpg

Spurious Correlations website: http://www.tylervigen.com/spurious-correlations

Quick Trend Following Q&A: Price and Volume

Michael Covel on iTunes
Michael Covel on iTunes

Price is key when trading. Consider from, Trend Commandments:

Tell me something the “market” does not know. The idea that you can know enough about Apple, oil, GE, and gold to trade them all the same way may seem preposterous, but think about what they all have in common: Price.

Market price is objective data. You can look at individual price histories, without knowing which market is which, and still trade all successfully. That is not what they teach at Harvard, Wharton, Kellogg, Stern, Darden, or pick your favorite business school du jour.

However, the concept of price as the critical trading cue may be too simple for mass acceptance. For example, a prominent business anchor opined: “At some point, investing is an act of faith. If you can’t believe the numbers, annual reports, etc., what numbers can you believe?” A longtime financial reporter at Fortune magazine was also on the highway going the wrong direction: “If some of the smartest people on Wall Street can’t trust the numbers, you wonder who can trust the numbers.”

You can never trust those numbers—that is, the reported firm details—completely. Someone can always alter them (remember Enron had a fake trading floor). Beyond that, even if you know accurate balance sheet numbers, how does this help you determine when or how much to buy or sell?

The market is always right, and price is the only true reality in trading. If you want to make money in any market, you need to mirror what the market is doing. If the market is going down and you are long, the market is right and you are wrong. If the market is going up and you are short, the market is right and you are wrong. Other things being equal, the longer you stay right with the market, the more money you will make. The longer you stay wrong with the market, the more money you will lose.

You do not need to know anything about bonds. You do not need to understand different currencies. They are just numbers. Corn is a little different than bonds, but not different enough to trade them differently. Some people have a different system for each market. That is absurd. You are trading mob psychology. You are not trading corn, soybeans, or S&P’s. You are merely trading numbers.

Some feedback from a listener on price:

Dear Michael, I think that you have done a great work in explaining what trend following is. However, there are two great arguments that you have never faced:

1. You have always discussed price. I know that prices constitute a trend. Nevertheless, you should interview some of the main traders that [use] volumes. I would like to know how great traders interpret volumes as they are the first step for an incoming new trend. This study is lacking in all your work. It would be very helpful to know anything about that.

2. You have always talked about trends. It is correct. However, it is better to buy a stock that is likely to have a +200% uptrend than a stock that is only likely to have a +20% uptrend. So the questions is: how do great trend follower traders make their picks by relying their choice ONLY on prices and volumes?

I will wait for a polite answer of yours.

Kind regards,
[Name]

You can’t predict the next 20% v. 200% move. Impossible.

Volume? That is not the main topic of conversation in my trend following world.

Good place to start: Read (PDF).

More to read.

Curiosity Should Take The Drivers Seat

I have written multiple books. All from a different perspective, but still all having trend following connective tissue. Consider an excerpt from the preface of my first book Trend Following:

Trend Following challenges much of the conventional wisdom about successful trading and traders. To avoid the influences of conventional wisdom, I was determined to avoid being influenced by institutionalized knowledge defined by Wall Street and was adamant about fighting “flat earth” thinking. During my research, starting with an assumption and then finding data to support it was avoided. Instead, questions were asked and then, objectively, doggedly, and slowly, answers were revealed.

If there was one factor that motivated me to work in this manner, it was simple curiosity. The more I uncovered about trend followers, the more I wanted to know. For example, one of the earliest questions (without an answer already) was learning who profited when Barings Bank collapsed. My research unearthed a connection between Barings Bank and trend follower John W. Henry (now the majority owner of the Boston Red Sox). Henry’s track record generated new questions, such as, “How did he discover trend following in the first place?” and “Has his approach changed in any significant way in the past 30 years?”

For those that follows my work, you can see how my foundation has remained the same over the past 15+ years:

Hi Michael,

Would you please clarify the chronology of your 4 books? What order were they written and published? Thank you.

[Name]

Trend Following
The Complete TurtleTrader
Trend Commandments
The Little Book of Trading

That is the order, but the content can be read in any order. Timeless.

Ep. 380: Lessons from Ken Tropin with Michael Covel on Trend Following Radio

Ken Tropin
Ken Tropin

Subscribe to Trend Following Radio on iTunes

On today’s show, Michael Covel talks about how people that are ahead of the curve often find themselves isolated – even ridiculed – by those who don’t yet get it. This, as Michael points out, is certainly true for trend following traders, and some of the sharpest push back comes from the talking heads of the media.

To emphasize his point, Michael plays clips from an interview between CNBC’s Joe Kernen and Graham Capital’s Ken Tropin, a highly successful trader who heavily incorporates trend following techniques into his overall strategy. To Michael, of utmost significance in the two men’s exchange, is the fact that Kernen bumbles through the interview wholly unprepared (either via incompetence or on purpose). Kernen didn’t respect Tropin or his strategy enough to do even the most basic homework beforehand.

Michael’s discussion then moves on to the topic of uncertainty. In direct opposition to media personalities, that are paid to pretend to know what the market will do, trend following traders embrace the knowledge that they can’t predict the future. Uncertainty makes the game more exciting, and not just the investment game. As Michael demonstrates, the principles of trend following can be effectively applied across myriad disciplines.

In this episode of Trend Following Radio:

  • Recognizing that without a strategy, you’re at the mercy of the machine
  • Embracing uncertainty
  • Understanding that knowing every market move won’t help without a plan
  • The importance of setting your strategy beforehand
  • Seeing that media personalities are paid to pretend to know all
  • How the principles of trend following apply to other disciplines

“Trend following is one of the most mature and well-established systematic trading styles with a thirty-three year track record of profitability.” – Ken Tropin

Mentions & Resources:

Listen to this episode:

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Approach the Market in a New Way

Feedback in:

I want to thank you for writing your books. They got me to approach the market in a new way. I have dived head long into algo/quant trading through trend trading. As long as you trust the system and follow through you will succeed. I think that the simpler systems are better than complex. Also the markets are noisier than they were 20 years ago which make trend trading harder, but it is still the most successful method for trading. Thanks again Michael.

[Name]

Thanks.

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