Sunday, December 07, 2008

Trend Following

I've been trying to write a blog on trend following for about a week now, but each time I sit down to write, there is yet another distraction in my thoughts, driving off the nearest exit and following some back road in my mind to places that have nothing to do with trend following. But persistence is a trait I have mastered and this subject is too important to be sidetracked by the assorted circumstances of an anything but staid life.

This particular journey was too good to be left untold. I reluctantly paid a visit to Trader Joe's yesterday. I didn't want to go, but out of my daily trading nourishment staples, organic milk and cereal, I knew that if this task was not undertaken in a prompt and efficient manner, I would rue my laziness at a most inopportune time. So off I went, in my best impersonation of Hank Moody, rumpled clothes and two-day beard, gum in lieu of a hanging cigarette and only a passing hand upon my head as my grooming for the occasion.

In the isle of juices, I came upon her. A 40ish blond, tall and thin, blue eyes deep and penetrating all encased in skin so creamy white and utterly appealing that my inquiry of her, "What does pomegranate juice taste like?" spurted out of me before my mind could alert me that coming on to strangers in public is tactless and rude and fully the most risky behavior in the middle of a Saturday that a single man can embark upon if he has any dignity or self respect left at all.

Twenty minutes later I am leaving the store with her email address and a promise to make me her famous pomegranate martinis at some undetermined time, so I can integrate the juice of the pomegranate into my life that somehow, in my romantic stupor, was moronically stated as in need of the aphrodisiac qualities she described of this mysterious berry.

I bring this up only to show how the time otherwise allocated to writing a blog about Trend Following was usurped by what can only be described as biological based unfettered insanity in the presence of such overpowering female power shrouded in a pink and white sun dress loosely clinging to a form so perfect that wars would be fought and armies slaughtered to return her to the throne to which she so clearly belongs.

Pomegranate martinis. Such are the rewards that inure to the victors of market timing. What better allegory then this nectar of the Gods to remind us all what it is we are doing here. Our object is to win this game, pocketing the spoils of the market wars as those lessor souls forfeit to us in this marketplace of stocks, etf's, derivatives and gold. Humbly kneeling before the blond Goddess, oh ye of little faith, rise up and take your place among the victorious and righteous noblemen who through the ages have conquered their fear and vanquished their enemies before the magical splendor of Aphrodite.

But I digress.

Morphed into a Sunday morning, refrigerator and pantry stocked, we turn once more to the art of living off of trading platforms on our screens, no commutes, no ties, no office politics, just one on one jousting for the pot that lays in the center of the table. As every day brings front page stories of fallen hedge funds, largely absent from the reporting are tales of the winners, the ones that take the pot game in and game out, for every dollar lost, a dollar is won, but who is leaving with the prizes?

About three years ago, I read a book by Michael W. Covel, "Trend Following, How Great Traders Make Millions In Up Or Down Markets." In over 400 pages, the book made the case for trend following as the preeminent market strategy of our time. It heralded the work of Richard Dennis and is famous experiment of taking 20 novice traders and making the vast majority of them millionaires by teaching them a simple trend following algorithm.

That trading methodology is almost identical, in it's core approach to trading, to the same basic tenants of Market Club's Triangle Trading which I have written about extensively over the past year.

As for the aforementioned winners, who by definition have been cleaning the clocks of everyone else in this bear market, are the Trend Following hedge funds and traders who have been anchored short for the past 18 months because, well because the equity markets themselves have been in a steep downtrend. That's what trend followers do, they mirror the markets.

Such a simple and colossal notion that by it's very humble and unassuming premise goes so largely unnoticed in the blogosphere, on CNBC, in the New York Times and in the myriad of esoteric notions on how to pick tops and bottoms, in concepts of oversold and overbought and sadly (for some) in the brokerage accounts of the vast majority of market participants.

Chasing the latest market fad isn't all bad.

Some investment funds that jump on trends are outperforming traders who pride themselves on outthinking the market. Increased volatility in markets from commodities to stocks is helping the trend followers profit.

A particular category of trend-following funds called managed futures funds have outperformed hedge funds this year by making a killing from the dollar's rally, the plummet of emerging markets and the collapse of commodities.

With $234.1 billion in assets, these funds gained 8.9% year to date through October, while the average hedge fund lost 18.9%, according to preliminary data from research firm Barclay Hedge. Barclay, which isn't related to Barclays PLC, doesn't consider managed futures funds to be hedge funds, though other data trackers do.
Wall Street Journal, November 5, 2008

What is the common denominator of "...the dollars rally, the plummet of emerging markets and the collapse of commodities..."?

Trend following, in all of it's unsung glory.

I will be writing more on this subject in the coming weeks. For now, I want to provide some food for thought with the following excerpt from Covel's book:

Final Thoughts

Tom Rollinger, a friend of mine in the hedge fund world, approached me this spring about attending an investment conference in La Jolla, California, co-sponsored by Altegris Investments, Inc. Tom had just accepted an invitation to join Altegris. Altegris had placed over $1 billion in client assets with various fund managers of futures trading programs, commodity pools, and hedge funds, including significant placements with trend followers. Upon my arrival at the conference, Tom introduced me to the President and CEO of Altegris, Jon Sundt. Jon's presentation at the conference hit home. He postulated:

"Can a great trader have great skill and no opportunity to make money? Can a bad trader have no skill and tons of opportunity to make money? The answer is yes to both questions. Luck is at play in the short-term for most traders. There will always be "some guy" with a great one-year return, but the sustained edge appears only over time."

What's Jon's big picture point? He wants you to think about what happens when the bad trader with no skill finally finds himself with no opportunity. If you don't want to embrace his wisdom, you will eventually feel the pain in your trading account.

There will always be crictics, and there will always be cheerleaders. I, however, find solace in the performance numbers. And trend following performance numbers are the real story. No matter how many people agree or disagree with the content of this book, the performance numbers paint a picture you either accept or reject---it's your choice.
A

14 comments:

Anonymous said...

Allan,

Great post. Once again rather than dealing with non-problems and non-issues you get to the core of the issue and provide concise principles that will deepen our understanding and improve our success.

I hope to be able to make useful comment contributions to your blog once my skills increase.

Allan said...

Anon: Thanks for the thumbs up. Remember that most of what is available about trading and investing is bullshit. Some of same does slip into my blog form time to time, it's inevitable. Nonetheless, try to cut through the crap out there and soak up as much reality as is possible and there nothing as real as price movement. The less baggage between you and price movement, the easier it is navigate your course to success.

david said...

Great post.

As for the notion that most of what is available about trading is BS, even a newbie like me has begun to figure that out. I'm sure it is much easier to make money giving advice about the market than it is to make money in the market. My favorite line from the turtles article (which I will be studying intently in the days ahead) was "There are a lot of individuals who try to sell themselves and their advice as expert. The best advice comes from those who aren't selling it, and who make their money trading." Looking forward to continuing to learn from your advice.

Chad Liddell said...

Hi Allan,

I appreciate the timing of this post. Quite a few bloggers have posted a chart akin to the chart linked below in the last days. I'm wondering if you would mind commenting on it?

http://stockcharts.com/h-sc/ui?s=$SPX&p=D&yr=0&mn=3&dy=0&id=p59562729289&a=156266301

Thanks!

Allan said...

Chad: Useless.

Chad Liddell said...

Allan,

Care to elaborate? I'm just trying to figure it out and a significant percentage of the bloggers I follow regularly are pointing out that the primary line looks like it's broken. Here's an example-

http://tradermike.net/2008/12/december_5th_stock_market_recap_and_stocks_to_watch/

I try and stay as flexible and unemotional about my trades as I can and when I do I find I have the most success. This week's action was considerably more bullish than I would have expected and this trend line break seems significant. If it's not I'm curious why you think it isn't? Thanks again.

Allan said...

Chad, quick answer since Californication is on in three minutes. Your chart shows the S&P forming a wedge, but there is no clear break above or below the wedge. The next few bars can be up, or down or both, in that order or in reverse order. See what I mean? As a trading tool, as of that snapshot, there is no indication which way the prices will break.

A

Anonymous said...

Allan,

To what extent does the Triangle Trading System disclose their rationale for triggering buy and sell signals? I would like to become an independent trader instead of blindly following a subscription service (give a man a fish versus teach a man to fish).

Thanks in advance, and nice blog you have here.
Big Tony

p.s. - can Gonzaga win it all this year?

Anonymous said...

Ahh Allan:

Alas, we meet yet again.

I am pleased to see you are integrating the Gods into your trading and lifestyle.

I think you will find that a small sacrifice to the Goddess Venus may be of help with the email address you have "inadvertently" received.

We Greeks consider the Gods THE central part of our lifestyle and I personally have used their sage advice to "mine" your blog for its best trades.

Keep up the good work, and always keep Olympus in mind.

I made a killing on NNVC, cashed out of 2/3rds of my position and then it crashed. Personally I am looking to Perseus for some kind of miracle here. Whether it will be forthcoming is another matter,it means I may have offended him in some way.


Leonidas
Southern Greece

Wayne said...

Hi Big Tony,

The triangles are basically new 3-period highs (green) or lows (red), whether those periods be day, week, month, etc.

I'm working on an Excel back-tester to see how triangles would have fared for various ETF's and stocks in various markets in the past. This is part of an overall project I've taken up to research the effectiveness of various trading strategies.

Over time I hope to pair the triangles indicator with other indicators to come up with a trading strategy that at least can be proven profitable over past price movement. Meanwhile I'm basically monitoring this blog for Allan's advice and predictions on market direction. He's been uncannily accurate so far!

Regards,
Wayne

Anonymous said...

who cares about trading......tell Her about your blog....maybe she'll GET LUCKY!! Get it Allan? gary

Anonymous said...

Well, hard times I know, but we should all chip in and donate enough that Allan can take this lass out for a beautiful evening on the town, on us!

Allan said...

Big Tony: Will try to make the Gonzaga v. Arizona game coming up in Phoenix, but its the day after the Red Wings are in town to play the Coyotes and decent seats are $250 - either go along or have my date wait outside in the car?

Leonidas: The defeat of the Persians in 479 BC left Greece as the single most powerful
nation on the earth. Has anything changed?

A

Anonymous said...

Many of the Trend Followers Mr. Covel has touted have blown up: Jason Dekker formerly of Dekker Capital, Bill Miller of Legg Mason, John W. Henry, Bill Dunn, etc. They have lost huge amounts of money for people.