Trend Following, 5th Edition
We exchange small talk. Trader Guyâ€™s diffidence makes it clear he has no interest in chatting. We are both heading out to the valetâ€”these places wonâ€™t let you park your own carâ€”and a rather memorable few moments ensued.
Trader Guy knows who I am. My book on the financial crisis had come out the prior year; I had already been a regular in the financial media for a while. He knows my name and, truth be told, he could not possibly have cared less. If only to be polite to the host who introduced us, I ask what sort of trading he does. Trader Guy actually sighs deeplyâ€”then says to me, â€œI trade everything, I am a trend follower, you wouldnâ€™t understand.â€
â€œWhat a coincidenceâ€ I say. â€œA friend of mine wrote a book on trend following.â€
By now, I have exhausted what little patience Trader Guy had with me to begin with. I actually heard his eyes roll.
â€œListen, dude, itâ€™s really cute you have a friend who wrote a book on this, but there is only one book on the topic, every other one is crap. Your pal wasted trees writing his. The definitive book on the subject, the only one that matters, is called Trend Following. Everything else is a waste of your time.â€
I tried, I really tried so hard not to smirk.
As best as I could with a straight face, I casually say: â€œYeah, thatâ€™s the one. Thatâ€™s the book Mikeâ€”my friend Michael Covelâ€”wrote. Trend Following.
Talk about an attitude adjustment: Trader Guy has a genuine come-to-Jesus moment, turning into a smitten schoolgirl: â€œOhmygodOhmygodOhmygodâ€”you know Mike Covel? I love that book, I love Trend Following! I was a failing trader, about to get blown out of the business. I read that book, and it turned my whole life around. I owe that guy my entire career!â€
Ahhh! The tables have turned. Now it is my turn to have a little fun:
â€œI keep telling Mike he needs to punch it up, make it more colorful, add a section on forecasting economic data, evaluating corporate management, and analyzing geopolitics. Make it fresh and interesting.â€
Long pause as Trader Guyâ€™s jaw drops.
It takes him a few seconds before he realizes that: a) I am totally kidding; b) I understand how irrelevant those things are to trend followers, and; c) I am busting his chops for being such a hard ass before.
Trader Guy laughs as I am now deemed worthy. We are suddenly best buds: We chat about what we were short during the crisis (AIG, Lehman, Bear), the equity rally off of the lows (strong), and the gold run (at risk of breaking), dollar trending. His car pulls up, we keep talking. My car comes around, and we are still talking. Mr. Diffident has morphed into Mr. Conversationalist.
All of which goes a long way towards explaining why the book in your hands, now in its fifth edition, has become one of the most popular trading books ever written.
What are the characteristics that make Trend Following so unique? I have my own biases. I see the inherent and natural flaws of human psychology as an investorâ€™s biggest flaws. Like our inability to understand risk and data and statistics, our obsession to be right, and the ways our wetware constantly fool us into believing things that objectively are not true.
Hence, my top ten reasons I like Trend Following reflect all of that:
- It is an objective, price-based approach.
- News headlines, pundits, analysts, and opinions are not meaningful.
- It has risk management built into it.
- Specific views on â€œThe Fundamentalsâ€ are not relevant.
- It is methodical and systematic.
- The same exact strategies apply across all asset classes.
- It does not require any predictions.
- Time frames are long-term in nature.
- Economic dataâ€”Employment, GDP, Fed, etc.â€”are irrelevant.
- It demands a very exacting personal discipline.
Readers may find that other aspects of trend following that resonate more for them. It depends on your own personality. But what does not vary for any trend follower is understanding the specific underlying philosophy, and having the discipline to follow that approach with unwavering, religious dedication.
I have a few complaints as well. It gives you nothing to talk about at cocktail parties or barbecues. It is less intellectually stimulating than say debating whether and when the FOMC should or should not (or will or will not) raise or lower rates next meeting. It can be boring. And, there are long stretches of time where the trend is neutral, and you are doing nothing.
Anyone can learn the methods Covel discusses here. Putting them into action requires commitment to the craft, and a military discipline. The Achilles heel of so many traders is a lack of precisely those qualities. As you will learn, Trend Followers must be willing to tough out some difficult sledding. It is an old joke but itâ€™s true: If it was easy, everyone would be rich!
But it is not easy. Anyone who has lived with a major drawdown understands how your own body responds. Physical and emotional tolls are not insignificant. You lose sleep, you have a low-grade headache for days or weeks at a time, and some people respond with physical nausea. The biggest issue comes in the hit to self-confidence. Riding out the loss of capital leads traders to question themselves and to doubt their methodology. They wonder if maybe it really is different this time. Market structures have changed, the Fed is doing something unprecedented, high-frequency trading is new, or perhaps it is ETFs, they think something is different this time around. â€œPerhaps if I just tweak the approach a little here this once . . .â€ are famous last words.
To those who master the techniques described herein, there are profits to be had. But it is not for everyone, and if you are unable or unwilling to ride out the losses, accept drawdowns in capital, be bored through periods of tedium and inactivity, to have the discipline to follow your strategy, to you I say, â€œMove along. Trend following is not for everyone.â€
For those who want to learn the craft of trading, have the personality and discipline, and are willing to do the heavy lifting, read on . . . you wonâ€™t regret it.
â€”Barry L. Ritholtz
Chairman, Chief Investment Officer, Ritholtz Wealth Management
Columnist for Bloomberg View and Washington Post
Host of Masters in Business radio podcast for Bloomberg
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