Investment manuals suffer another deficiency, which is that expert (and I use the term advisedly) opinion in the field tends to be cyclical, not cumulative. One would not expect to see a home improvement volume with the title The New Reality of Plumbing. But the science of investing, at least as it is propagated by financial writers, undergoes a seeming revolution every couple of thousand points on the Dow.
Two lessons from the St. Petersburg Paradox. The risk-reducing formulas behind portfolio theory rely on a number of demanding and ultimately unfounded premises. First, they suggest that price changes are statistically independent from one another…The second assumption is that price changes are distributed in a pattern that conforms to a standard bell curve. Do financial data neatly conform to such assumptions? Of course, they never do.
Benoit B. Mandelbrot
“Jesse Livermore described Wall Street as a ‘giant whorehouse,’ where brokers were ‘pimps’ and stocks ‘whores,’ and where customers queued to throw their money away.”
Another psychological aspect that drives me to use timing techniques on my portfolio is understanding myself well enough to know that I could never sit in a buy and hold strategy for two years during 1973 and 1974, watch my portfolio go down 48 percent and do nothing, hoping it would come back someday.
With the title alone causing hysterics, placing this on your coffee table will elicit your guests to share their best dot-com horror story. How they invested their $100,000 second mortgage in Cisco Systems at $80 after reading about it, waiting for it to become $500 (as predicted in this very book) only to see it dive to $17. Just the thought of this book gives me the chuckles.
Amazon.com Review of Dow 36,000
You will run out of money before a guru runs out of indicators.
Neal T. Weintraub
There is little point in exploring the Elliott Wave Theory because it is not a theory at all, but rather the banal observation that a price chart comprises a series of peaks and troughs. Depending on the time scale you use, there can be as many peaks and troughs as you care to imagine.
If you want a guarantee, buy a toaster.
You have to say, “What if?” What if the stocks rally? What if they don’t? Like a catcher, you have to wear a helmet.
Jonathan Hoenig, Portfolio Manager,
Capitalistpig Hedge Fund LLC
There is no greater source of conflict among researchers and practitioners in capital market theory than the validity of technical analysis. The vast majority of academic research condemns technical analysis as theoretically bankrupt and of no practical value…It is certainly understandable why many researchers would oppose technical analysis: the validity of technical analysis calls into question decades of careful theoretical modeling [Capital Asset Pricing Model, Arbitrage Pricing Theory] claiming the markets are efficient and investors are collectively, if not individually, rational.
The biggest cause of trouble in the world today is that the stupid people are so sure about things and the intelligent folks are so full of doubts.
We are what we repeatedly do. Excellence, then, is not an act, but a habit.
Forecasts are financial candy. Forecasts give people who hate the feeling of uncertainty something emotionally soothing.
Thomas Vician, Jr., student of Ed Seykota’s
Never let the fear of striking out get in your way.
The Henry theory— statistically corroborated, of course—is that assets, once in motion, tend to stay in motion without changing direction, and that turns the old saw— buy low, sell high—on its ear.
Enron stock was rated as “Can’t Miss” until it became clear that the company was in desperate trouble, at which point analysts lowered the rating to “Sure Thing.” Only when Enron went completely under did a few bold analysts demote its stock to the lowest possible Wall Street analyst rating, “Hot Buy.”
February 3, 2002
“If you don’t risk anything, you risk even more.”
“No matter what kind of math you use, you wind up measuring volatility with your gut.”
The best place to live on this curve is the spot where you can deal with the emotional aspect of equity drawdown required to get the maximum return. How much heat can you stand? Money management is a thermostat—a control system for risk that keeps your trading within the comfort zone.
[I]f you’re trying to reduce the volatility or uncertainty of your portfolio as a whole, then you need more than one security. This seems obvious, but you also need securities which don’t go up and down together [reduced correlation]… It turns out that you don’t need hundreds and hundreds of securities [to be diversified]. Much of the effective diversification comes with 20 or 30 well selected securities. A number of studies have shown that the number of stocks needed to provide adequate diversification are anywhere from 10 to 30.
Mark S. Rzepczynski
John W. Henry & Co.
People tend to use discretion or gut feeling to determine the trade size.
Volatility, risk, and profit are closely related. Traders pay close attention to volatility because price changes affect their profits and losses. Periods of high volatility are highly risky to traders. Such periods, however, can also present
them with opportunities for great profits.
Sound investment policy is really about intelligent risk management. There is no such thing as a risk free investment. The real issue is not whether you want to take risk, but which risks and how many of them you are willing to accept.
Jim Little and Sol Waksman
If you have a $100,000 account and you’re going to risk 5 percent, you’d have $5,000 to lose. If your examination of the charts shows that the price movement you’re willing to risk equals $1,000 per contract, then you can trade five contracts. If you want to risk 10 percent, then do 10 contracts.
The most important aspect of any trading decision is never the condition of the market, but rather that of your own position. The trick is to be constantly moving toward a position of strength, both within an individual trade and within the marketplace at large. Just like basketball, chess or any other activity that requires focus, you know you’re in the “zone” of trading when you start playing for position, not for points.
Jonathan Hoenig, Portfolio Manager,
Capitalistpig Hedge Fund LLC
There is a random distribution between wins and losses for any given set of variables that defines an edge. In other words, based on the past performance of your edge, you may know that out of the next 20 trades, 12 will be winners and 8 will be losers. What you don’t know is the sequence of wins and losses or how much money the market is going to make available on the winning trades. This truth makes trading a probability or numbers game. When you really believe that trading is simply a probability game, concepts like “right” and “wrong” or “win” and “lose” no
longer have the same significance. As a result, your expectations will be in harmony with the possibilities.
Trading in the Zone
If you look at the past 30 years, there is only one fundamental investor who has consistently produced huge absolute returns—Warren Buffet. Compare that, however, with countless trend following traders who have outperformed throughout bull and bear market cycles. One of the keys to our success is to have a huge diversification of over 100 financial and commodity markets. A systematic, mechanical approach is the only way to successfully trade so many markets…every decision…from market entry, position sizing, stop placement…must be fully automated.
In limiting risk, people also limit the opportunity for gain. It is common, today, for investors to own six or eight mutual funds, each of which is likely to be invested in hundreds of stocks. This will, they hope, assure that no little bump, no
little meltdown, overly upsets their portfolios. But since when was investing about avoiding the bumps?
“The Way We Live Now; See a Bubble?”
What are the three best market indicators? In order they are: 1. Price 2. Price 3. Price
You’ve got to think about big things while you’re doing small things, so that all the small things go in the right direction.
“I didn’t necessarily have system creation as a goal…What I did have as a goal was supplementing my fundamental trading with some technical insights.” What resulted was his long-term technical system that he realized worked well for diverse markets, not just grains. He says that moving away from fundamentals made it easier to create something that held true for a variety of markets.
Futures Magazine, August 2001
I learned you are not trading a commodity— you are buying and selling risk. As a technical trader, that’s the only way to look at it.
Mark van Stolk
From the beginning of my investigation, it became evident that the most direct way to make money and the one most compatible with my strengths was to be a position trader using computer models to develop the entry and exit points.
Michael J. Clarke
Clarke Capital Management, Inc.
Reason’s biological function is to preserve and promote life and to postpone its extinction as long as possible. Thinking and acting are not contrary to nature; they are, rather, the foremost features of man’s nature.The most appropriate description of man as differentiated from nonhuman beings is: a being purposively struggling against the forces adverse to his life.
Ludwig von Mises
Evaluating quantitative traders is much more about understanding their research process than looking at the last few years of a track record. The firmest grasp of all the individual, specific risks involved; the most critical and accurate analysis of the inherent underlying assumptions of their research; the knowledge of which statistical measurements are applicable or not; the creation of the purest mathematical descriptions of price structures, moves, and volatility …these abilities will determine the trader most likely to deliver the highest reward-to-risk in the future.
Quantitative Capital Management, L.P.
The peripheral mishigas, your attitude, wardrobe, education, and expertise mean nothing to the market. From old-timer to first-timer, it will chew up a doctorate just as easily as a drug addict…in the markets and indeed in life, success starts with realizing that one’s opinion means nothing. The market will move as life will move, perfectly unpredictable and with the best laid plans going horribly awry. We can’t control the market just as we can’t control the future. So the winners are simply those best positioned to benefit from a future not yet seen.
Jonathon Hoenig, Portfolio Manager,
Capitalistpig Hedge Fund LLC
Robert Hormats, the vice chairman of Goldman Sachs International, observed that to understand and explain globalization, it is useful to think of yourself as an intellectual nomad. In the world of the nomad, there is no carefully defined turf.
Whales only get harpooned when they come to the surface, and turtles can only move forward when they stick their neck out, but investors face risk no matter what they do.
Charles A. Jaffe
I heard this story and I think it’s true. Anyway, it’s a pretty good story. It’s about how the Air Force trains pilots. When a trainee made a good landing, he would be praised. When a trainee made a bad landing, he would be ridiculed. Well, it was perfectly clear to the general that the first approach was lousy and the second approach was good. He had statistics demonstrating that when you praised a pilot who made a perfect landing, his next landing was not likely to be as good. Whereas, if you berated a pilot who made a bad landing, his next landing was likely to be much
better. However, if you think about it, it doesn’t matter what you do because landings are most likely to be average If a pilot had an exceptional landing, his next landing was likely to be average. If he had a poor landing, his next landing was likely to be average, also. By slicing the data and only looking at what follows good landings and praise, you only see part of the picture. You must consider how data was selected before you can draw conclusions.
The Greenwich Roundtable
June 17, 1999
The obvious is always least understood.
Prince Klemens von Metternich
Day trading is emotional anesthesia—the frenetic pace works well to keep people preoccupied from feelings they do not wish to experience.
Thomas Vician, Jr.,
student of Ed Seykota’s
…it is important to understand that in trading, as in real life, risk is an integral part of the process and one that deserves great respect. To earn a considerable return, one must take a comparable risk. It is essential, therefore, to have accurate measures of both risk and reward.
Cipher Investment Management
Life shrinks or expands in proportion to one’s courage.
Larry Hite described his conversation with a friend who couldn’t understand his absolute adherence to a mechanical trading system. His friend asked, “Larry, how can you trade the way you do? Isn’t it boring?” Larry replied, “I don’t trade for excitement; I trade to win.”
Many turtles claim the biggest reason they no longer tolerate immense drawdowns or strive for colossal returns is because customers want a more conservative approach. Most say striving to meet this request has been the biggest change.
…a CTA [trend following] investment is an investment like any other investment. Periods of above-average performance are alternated with periods of below-average performance. As soon as the inevitable, less attractive market environment commences, investors with wrong expectations are likely to become disgruntled. They will start complaining and with good reason: They will not understand why they lose money.
Harold M. de Boer, director of research, Transtrend B.V.
AIMA Journal, December 2003
The broad application of these principles globally in markets all around the world, Chinese porcelain, gold, silver, markets that exist, that don’t exist today, markets that others are making lots of money in that we’re not trading. We will eventually start broadening out and realizing that trend following is a great way to trade. What other way can you trade and get a handle on risk?
Future shock [is] the shattering stress and disorientation that we induce in individuals by subjecting them to too much change in too short a time.
Most battles are won before they are ever fought.
General George S. Patton
The Sharpe ratio appears at first blush to reward returns (good) and penalize risks (bad). Upon closer inspection, things are not so simple. The standard deviation takes into account the distance of each return from the mean, positive or negative. By this token, large positive returns increase the perception of risk as though they could as easily be negative, which for a dynamic investment strategy may not be the case. Large positive returns are penalized and therefore the removal of the highest returns from the distribution can increase the Sharpe ratio: a case of “reductio ad absurdum” or Sharpe ratio as a universal measure of quality.
David Harding, Winton Capital,
Everyone wants to invest when you’re at new highs and making 50 percent a year. Everyone says they want to get in at a 10 percent drawdown or a 20 percent, or whatever, and no one ever does it. I just want to point out that right now, here is another chance to do just that—buy us at historical lows—and very few people are thinking in those terms. They want to buy the lows, but never seem to.
For example, today is in the middle of June and there is a lot of talk about the weather, the grain situation, and whether it rains or snows or is dry. I have no idea. It’s not the kind of thing I deal with. I don’t have any way to use information like that. I don’t think anyone else really does either … If I think it is going to rain, perhaps it’s an indication of how I should dress for the day, but little else.
Optimism means expecting the best, but confidence means knowing how to handle the worst.
Most of the Ivy League guys I know are so used to being “right” they get very uncomfortable dealing with uncertainty —when there is no right answer. Their egos often make them so afraid of being “wrong,” that they’re unable to make good bets. They aren’t comfortable with the idea of risk, because they don’t know how to assess it or measure it. [They have been] taught to absorb knowledge, not what to do with it.
Larry Hite, Hite Capital
Our response to this environment has to be disciplined. If disagreement of opinions leads to trends, we need to maintain our positions. Similarly, we must be willing to close or change positions without ambiguity if called for. Risk management is especially opportune at this time. Will Rogers summed it up succinctly: “Even if you are on the right track, you’ll get run over if you just sit there.”
Mark S. Rzepczynski
President, John W. Henry & Company
I decided almost 20 years ago that rather than become an expert trend follower I could better leverage my time by becoming an expert at identifying other trend followers. The decision has been very rewarding. Having placed over a billion dollars with trend followers over the years, I have become increasingly convinced that the level of passion, discipline, intelligence and hard work to become a long term success at trend following is enormous.
Jon C. Sundt, President,
The market serves a valuable function in our economy not often talked about: It provides an efficient mechanism for transferring precious capital from those who are ill-equipped to steward its growth to those who are adept. A variety of market participants provide this service up and down the food chain. The financial markets are voluntary arrangements. No one is compelled to purchase a piece of trading software. No guns are involved in herding investors into seminars. Advisory letters are sent to those who willingly subscribe to them, and may be cancelled at will. Investors who avail themselves of these services without exercising due diligence and taking responsibility for their own actions are the true dangerous lot— they are a danger to themselves. They blame others for their bad decisions and misfortunes; they delude themselves about the true nature of their problem, so the solution remains ever beyond their ken.
Gibbons Burke, MarketHistory.com
I mean, look at the concept of price targets. Someone—analyst, mutual fund manager, whoever—will come on and say, “I have a price target for this stock of XXX—which is up 30pct from here.’’ I see it getting there over the next six months. Yeah right. When someone tells me they know where a stock is going, I can only laugh and ask them why they haven’t mortgaged the house and put it all in the stock. Of course I know the answer. They don’t want to put their money in the stock; they want YOU to put YOUR money in the stock so the price of the stock they own goes up. Get long and get loud. Why can’t we just admit they are pitching a stock and treat it like a trinket on QVC?
Mark Cuban, http://www.blogmaverick.com
If you have the good fortune to make some money in this world, you will always have detractors. John W. Henry, the owner of the Red Sox baseball team and one of the best trend followers ever, is no exception. Spring 2005 has seen the catcalls for John’s head in some investment circles. Why is this? You have a choice of answers: John’s success or his critic’s ignorance. It’s probably both. And for those who think Henry’s trading prowess has diminished, check out his approximate +9 percent return for May 2005 and for good measure his +9 percent for June 2005.
Let us believe that it is possible to profit through economic changes by following today’s trend, as it is revealed statistically day-by-day, week-by-week, or monthby- month. In doing this we should entertain no preconceived notions as to whether business is going to boom or bust, or whether the Dow-Jones Industrial Average is going to 500 or 50. We will merely chart our course and steer our ship in the direction of the prevailing wind. When the economic weather changes, we will change our course with it and will not try to forecast the future time or place at which the wind will change.
William Dunnigan (1954)
All trends are historical; none are in the present. There is no way to determine the current trend, or even define what current trend might mean; we can only determine historical trends. The only way to measure a now-trend (one entirely in the moment of now) would be to take two points, both in the now and compute their difference. Motion, velocity, and trend do not exist in the now. They do not appear in snapshots. Trend does not exist in the now, and the phrase, “the trend” has no inherent meaning…There is no such thing as a current trend. When we speak of trends, we are necessarily projecting our own definitions. With that in mind, we can proceed to examine ways to define,
compute, and use trends.
I met with a near billion dollar hedge fund in their Texas office in Spring 2005. Funded primarily from the principals’ personal wealth (they hit it big with one of the top technology firms of all time), their firm was seeking insights into trend following. They want to invest with trend following traders, but they are having a hard time wrapping their arms around a strategy (trend following) not rooted in fundamentals. The three executives I met with were more comfortable with a trader who traded one market alone. They liked the idea that a trader might be able to fundamentally know everything he could about that one market. They liked the idea of that type of skill compared to trend following skill. The trend following skill of reducing all markets to the common denominator of price just did not connect with them. This group is very bright and they are doing extreme due diligence on trend following trading. Unlike some who dismiss trend following, these folks will get it since they are willing to learn something new.
When you strip away all the noise, we see that long-term price movements, bull and bear markets, are a function of fear and greed. These human emotions, reacting to shifts and imbalances of supply and demand…will always exist. Superfund employs a disciplined, systematic approach and profits from investor emotion by harnessing clear price trends. Human emotion does not impact the positions we take or the open risk that we allow in our trades.
Christian Baha, CEO Superfund
Ed Seykota once told me a story about being in Bermuda with a new trader who wanted to learn the “secrets.” “Just give me the quick-and-dirty version of your magical trading secrets,” the neophyte said. Seykota took the new trader out to the beach. They stood there watching the waves break against the shoreline. The neophyte asked, “What’s your point?” Seykota said, “Go down to the shoreline where the waves break. Now begin to time them. Run out with the waves as they recede and run in as the waves come in. Can you see how you could get into rhythm with the waves? You follow the waves out and you follow them in. You just follow their lead.”