Tag Archives: Rational Markets

Trending

17 August 2023 By in Books Nonfiction, Trading Tags: , , , , , , , , , , , , , Leave a comment

Trend Following: How to Make a Fortune in Bull, Bear, and Black Swan Markets

Michael W. Covel

Published by Wiley

Copyright: © 2017

Michael W. Covel – Wikipedia

(Note: This is the third of 3 reviews detailing the stories and methods of stock market trend followers and traders that collectively became known as ‘Turtles’. The following short bio is a repeat from the second post in this series.)

Biography:

Michael W. Covel, 54, born in Virgina, is an author of 8 books on markets and trading with a specialization in the market technical analysis known as trend following or ‘Turtle’ trading.

He also hosts a podcast, ‘Trend Following Radio‘, which he has, to date, recorded more than 1200 episodes. The podcast follows a format of interviewing leading authorities in economics, trading, and various other topics of interest to the investment world.

Market Players:

People analyzing and trading the markets fall into two distinct groups: fundamental and technical. Those taking a fundamental approach to the markets tend to be long-term investors whereas technical analysts have a short-term focus.

A fundamental analyst of the market keys in on news and financial data to assess the relative strength of a security. These investors tend to adhere to the Efficient Market Hypothesis/Theory (EMH or EMT): that individual securities are fairly valued. Inherent to this theory is that markets are rational. Stock prices reflect all the information available and are not affected by emotional spasms otherwise known as volatility. Ha.

Actually, volatility is a well-defined statistical measure of a stock’s price swings away from its mean. Large price swings equate to high volatility. High volatility stocks are riskier stocks to trade because the price swings are large and unpredictable. There are those on the technical side of trading that believe that volatility and risk are unrelated, but this always seems to be, at its core, a sematic argument. Additionally, higher volatility stocks have a higher price premium built into their option prices.

By sifting through mountains of market news and financial data investors are attempting to identify financially strong securities to hold for the long term. Also, in their quest to understand and know the markets and companies, they hope to uncover the rare, undervalued security which may lead to significant profit. Ironically, undervalued, aka value stocks, belie the premise behind the EMH. Doubly ironic, searching for value stocks is akin to unicorn hunting, neither exists in the real world, so why bother, in my most humble opinion.

The timing of entry to and exit from a market trade is the greatest pitfall for a long-term investor. A trade may take the price elevator south, accumulating significant losses before there is any data, or none, to support its rapid descent.

A technical analyst is only concerned with the security’s price, and its current trend. Is it going up, down, or sideways? There is a belief that technical analysts and traders are attempting to predict the future direction of security’s price, but this is incorrect. Technical traders, using statistical probabilities, attempt to take the path of greatest potential profitability. The greatest downside to technical trading is that all statistical analysis of a security or market is calculated from data derived from the past and the present but never the future so even with the best tools trends reverse themselves with warning.

Technical analysts like to think of themselves as card counters at a blackjack table trying to ascertain when the deck is heavy or light in high cards. A higher ratio of high cards favors the player. Stocks with a strong trend favor the trader. The problem with this analogy is that the US market has close to ten thousand ticker symbols that trade daily or to keep the metaphor intact about two hundred decks of cards for the card counting trader to digest.

Ten thousand securities, all with their own trend or no trend, all in constant state of flux, it is difficult to consistently pick the stocks with the winning trend. Losses are and will be incurred under the best of systems. Successful trend followers exit losing trades when they are down about 20%. Exit your losers and quickly to stay in the game.

Whether a fundamental investor or a technical trader, forecasting price is fraught with danger and losses. In the immortal words of Niels Bohr, father of the mathematical foundations of quantum theory: “It is very hard to predict, especially the future.” (Quote and variations sometimes attributed to others such as: Samuel Goldwyn, Yogi Berra, and Mark Twain)

Trend Following:

Covel’s ‘Trend Following’ deals with the technical analysis of the markets with a not so insignificant dollop of whining condescension directed towards the fundamentalists. The book is divided into three sections. The first two sections, written mainly by Covel, define and explain market technical analysis and trading along with seven in-depth interviews with successful trend traders. The concluding section is a collection of trend following research papers written by experts in the field of technical analysis and trading. Interspersed throughout the book are a plethora of epigraphs, epigrams, and aphorisms, ranging in worth from the profound to the quaint. Most are the equivalent of footnotes, sometimes useful and instructive, but mostly time-consuming and distracting.

The first edition in 2004 was a manageable 256 pages. The second edition in 2005 increased in size by 65% and totaled 420 pages. The 2009 third edition was even fatter with 464 pages. The fourth edition I can find neither hide nor hair of, but it likely experienced similar inflationary page count pressures. The 5th edition of this book comes in at an eye watering 688 pages: 578 pages of trending stuff and 109 pages of footnote/index stuff. Stuff is the correct word, mostly.

This book is beginning to resemble the 3-semester text for college calculus where every possible type of integral insists on its 15 minutes of fame. Teaching and learning take a back seat to the authors’ need to impress their peers. For the sake of future readers interested in trading on the price trend let us hope that Covel may stop adding material and start addressing the always interesting topic of concision.

Trend following, trend trading, momentum investing, ‘Turtle’ trading all refers to the same basic method of analyzing the market: probabilistic analysis of the current price and the trend of its price history. The concept of price and its trend is too simple of a concept for a good chunk of Wall Street traders to accept but we all follow trends without thinking. We follow the herd when deciding where to shop, what schools to send the kids to, what books to read. Why are stock price trends anathema to a good chunk of the investor class? Who knows? Ed Seykota, one the world’s most successful trend traders’ comments, “All profitable systems trade trends.” Trading at a profit or loss implies a trend.

To evaluate the results of trading on the trend requires a focus on absolute return. All that means is that one makes the most profit possible. Making the most requires that the trader be on the right side of the market at the right time. Being on the right side of the market starts with not fighting the trend, going with the flow. When the markets or security are on an upswing do not try to convince yourself that a downturn is imminent, even though trend reversals are common, betting on reversals is the road to bankruptcy. The trend is your friend. Stay friendly. Stay profitable.

Michael W. Covel Media:

References and Readings:

The History of Turtles

13 August 2023 By in Books Nonfiction, Trading Tags: , , , , , , , , 1 Comment

The Complete Turtle Trader: The Legend, The Lesson, The Results

Michael W. Covel

Published by Collins

Copyright: © 2007

Michael W. Covel – Wikipedia

(Note: This is the second of 3 reviews detailing the stories and methods of stock market trend followers and traders that collectively became known as ‘Turtles’.)

Michael W. Covel, 54, born in Virgina, is an author of 8 books on markets and trading with a specialization in the market technical analysis known as trend following or ‘Turtle’ trading.

He also hosts a podcast, ‘Trend Following Radio‘, which to date has recorded more than 1200 episodes. The podcast follows a format of interviewing leading authorities in economics, trading, and various other topics of interest to the investment world.

The previous post, ‘Turtle of the First’ was from the perspective of Curtis Faith who, in 1984, began his trading career in the first class of Richard Dennis’ ‘Turtles’. Michael Covel’s book is from the perspective of an outsider looking in. Before moving onto Covel’s story a quick recap from the previous post.

In 1983 Richard J. Dennis and his partner at C&D Commodities, their Chicago trading firm, budgeted $15,000 to run a recruitment ad in the Wall Street Journal, Barrons, and the International Herald Tribune seeking recruits to train in futures trading:

…Mr. Dennis and his associates will train a small group of applicants in his proprietary trading concepts. Successful candidates will then trade solely for Mr. Dennis: they will not be allowed to trade futures for themselves or others. Traders will be paid a percentage of their trading profits, and will be allowed a small draw. Prior experience in trading will be considered, but is not necessary. Applicants should send a brief resume with one sentence giving their reasons for applying…

From Richard J. Dennis et al ad in the above-mentioned newspapers and magazine.

From the replies to his ad Dennis chose 23 inductees into the ‘Turtle’ program that included college graduates with degrees in accounting, business, economics, geology, linguistics, marketing, music, and the US Naval Academy. Those from the paycheck world he picked a security guard, salesperson, broker, phone clerk, bartender, board game designer, and someone who listed himself as unemployed. An eclectic bunch for a very structured task indeed.

Dennis was looking for high IQ types willing to break from the herd and take risks. Intelligently calculated risks to be precise.

Dennis and his partner William Eckhardt taught the students in a conference room, not the trading pits, all they needed to trade in two weeks. Each student received $1 million to trade and was allowed to keep 15% of the profits.

They had one objective. Make as much money trading, on their terms, as humanly possible. It was definitely high risk, but the rewards were commiserate. The persistent need to win was mandatory if they were to survive as a ‘Turtle’.

Dennis insisted that to win, his students must always question conventional wisdom. He knew from experience in the trading pits that the majority opinion was wrong a majority of the time along with information coming from the news sources.

‘Turtles’ were discouraged from following the news, reading economic reports, or collecting stock tips because the markets move faster than information can be assimilated into the market. Or in other words information didn’t move the markets; people trading, often irrationally, did.

Conventional wisdom on Wall Street was to buy low and sell high. ‘Turtles’ tossed the conventional wisdom, bought high, and sold higher or shorted new lows.

Dennis and Eckhardt taught the ‘Turtles’ to follow the trend. They waited for the market to move then they followed it. Capturing most of the trend, up or down, was the goal.

They determined when to buy high, or to short stocks going lower, by observing breakouts in the markets or securities. If a stock made a new 20 or 55 day high, they bought the stock. If it made a new 20 or 55 day low, they shorted the stock. If the trend continued in the desired direction, they bought, or shorted, more of the stock. When the trend ended they sold.

It was a simple system and it worked exceptionally well for the ‘Turtles’ who collectively made profits of $175,000,000 over the 5 years they worked for Dennis’s firm. The spreadsheet to the right shows the individual ‘Turtle’ results while they were working for Dennis (source: Covel and the Wall Street Journal – not all ‘Turtles’ listed)

Michael W. Covel Media:

References and Readings:

Turtle of the First

10 August 2023 By in Books Nonfiction, Trading Tags: , , , , , , , , , , , , , , , Leave a comment

Way of the Turtle: The Secret Methods that Turned Ordinary People into Legendary Traders

By Curtis M. Faith

Published by McGraw-Hill

Copyright: © 2007

Curtis Faith — Amazon Picture

(Note: This is the first of 3 reviews detailing the stories and methods of stock market trend followers and traders that collectively became known as ‘Turtles’. Curtis Faith was a turtle and a trader. The two reviews following this one concern publications by Michael Covel a market writer and trading coach who has lectured and written extensively on trend trading and Turtles.)

In 1983 Richard J. Dennis and his partner at C&D Commodities, their Chicago trading firm, budgeted $15,000 to run a recruitment ad in the Wall Street Journal, Barrons, and the International Herald Tribune seeking recruits to train in futures trading:

…Mr. Dennis and his associates will train a small group of applicants in his proprietary trading concepts. Successful candidates will then trade solely for Mr. Dennis: they will not be allowed to trade futures for themselves or others. Traders will be paid a percentage of their trading profits, and will be allowed a small draw. Prior experience in trading will be considered, but is not necessary. Applicants should send a brief resume with one sentence giving their reasons for applying…

From Richard J. Dennis et al ad in the above-mentioned newspapers and magazine.

The ad was the opening volley to proving a nature versus nurture disagreement between Dennis and his partner William Eckhardt. Dennis believed successful trading could be taught. Eckhardt, a mathematician by training turned trader, believed trading was innate, natural, inborn. You either had it or you didn’t, and no amount of teaching could change that.

To settle the debate Dennis agreed to teach his trading style and rules to a select group, letting them learn the craft using his money. From the firm’s ad and a follow-up true and false questionnaire they cobbled together a group of candidates, 23 in two tranches of 14 and 9 that were taught the firm’s trading rules. The traders came to be known as ‘Turtles’ because Dennis had seen a turtle farm, of all things, in Singapore and he believed he could raise traders as efficiently as Singaporeans raised turtles.

Over the next 5 years the ‘Turtles’ as a whole earned, made is probably a better word, $175,000,000. Dennis won the bet, but he worried that no amount of instruction could ultimately overcome human nature. Not sure if the following quote is a contradiction or just plain old irony but he worried his ‘Turtles’ couldn’t remain true to their training, stating “I always say that you could publish my trading rules in the newspaper, and no one would follow them. The key is consistency and discipline.  Almost anybody can make up a set of rules that are 80% as good as what we taught our people. What they couldn’t do is give them the confidence to stick to those rules even when things are going bad” (from Market Wizards, by Jack Schwager).

Curtis Faith was a ‘Turtle’ selected in the first group and began trading under Dennis and Eckhardt’s tutelage in 1984. He was C&D Commodities’ most successful student, reportedly earning $31.5 million for the firm by the end of the experiment. To put that into context the 23 ‘Turtles’ as a whole averaged a little over $7.5 million each. Some twenty plus years later Faith published a book detailing his experience and methods living in ‘Turtle Time’ during the 1980s (apologies to Danny Flowers and Don Williams).

Faith was a risk taker, and he was probably the greatest risk taker of all the ‘Turtles’, even greater than Richard Dennis. Taking and managing risk is what traders do. They buy and sell risk. And you need nerves of steel or as Dennis states above: discipline. When managing risk, one needs a plan to get into a security and a plan to get out. In the immortal words in Don Schlitz’s 1976 song ‘The Gambler‘ made famous by Kenny Rogers: “You got to know when to hold them, know when to fold them…”

Traders buy and sell liquidity and price risk. Market Makers trade liquidity–making money off the spread between buy and sell prices. Speculators trade price risk. Buying low and selling high. Or with ‘Turtles’ buying high and selling higher or vice versa.

Speculators are not long-term investors. Speculators are short-term traders who have no desire or need to find the intrinsic or fundamental value of any security. Their only concern is price and which way is it moving; up, down, or sideways. The statistical analysis of price momentum and sometimes volume are the tools of the trade for the short-term speculators. This is usually referred to as technical analysis and technical trading.

Turtles are speculators, technical traders, playing trends in price that may not have a fundamental basis. Price trends without a fundamental basis are almost by definition irrational.

Adam Smith in his ‘Wealth of Nations’ postulated the first form of the Rational Choice Theory, that an individual’s actions are mostly selfish, which he dubbed the ‘Invisible Hand’. The theory suggests that individuals act in their own best interest and that their behavior is rational. At the beginning of the 20th century the hypothesis that the markets are efficient and rational began to take hold among traders and economists. This led to the Efficient-Market Hypothesis (EMH) or Theory that maintains that valuations or prices for assets such as stocks and bonds reflect all available information and are fairly valued. Only added information will then affect the price of an asset. This implies that it is impossible to beat the market. Just invest in DIAs, IWMs, SPYs, and QQQs and forget about them until you retire.

Faith and the Turtles say bunk to all that market rationality and index investing. Technical trading and trading like a turtle works because market movements are driven by the irrational collective behavior of the market participants or so they believed.

Turtles were trend followers attempting to take advantage of large price increases or decreases over a period of several months. Significant profitable trends happen infrequently with a high percentage of promising trend trades turning south soon after placing them. They experienced significantly more losers than winners but exited their losses quickly, usually around 20% below entry price.

Following trends is geared towards the present and what the market is currently doing. It is never about trying to predict the future. They entered trades when the calculated probabilities, through technical analysis, were in their favor.

The Turtle method was simple and easy to understand. The strategy could be summed up in one sentence. Trade with an edge, manage risk, be consistent, and keep it simple.

Trade with an edge. Have a plan and stick to it. Through experience or preferably back testing find a trading strategy that will have positive returns over the long run.

Manage your risk. Control your risk or in other words don’t bet the bank on a single trade and don’t hang onto your losers hoping for a turnaround.

Be consistent in executing your strategy. Do not jump into trades that look interesting but fail the tactical elements of your plan.

Keep it simple and follow your plan. Most of your trades may be losers but the winners will make up for the shortfall or drawdown. Think in terms of the long game and don’t fixate on the individual losing trades.

The Turtles tactics used in implementing their strategy were also simple.

  • Turtles traded liquid futures such as commodities, currencies, metals, energy, and bonds.
  • The Turtle’s most complicated tactic was position sizing the trades. Generally, the more liquid the market the fewer the contracts they traded.
  • The Turtles identified trends using two similar systems employing price breakouts at 20 and 55 days. They tried to enter as many of these breakouts as possible so as not to miss out on the rare but very profitable, large price movements.
  • All trades had stop losses.
  • Trade exits were set as a 10-day low for long positions and a 20-day high for shorts. They never exited a trade at maximum profitability but only when the end of the trend was evident.

Simple stuff and they made $175,000,000 with it. Dennis reportedly made $200,000,000 trading his own account.

References and Readings: