Matt Bowen
05-21-2005, 09:59 AM
Inside the Counterintuitive World of Trend Followers:
It's Not What You Think. It's What You Know.
by: By Charles Faulkner
http://www.sfomag.com
-------------------------------------------------------------------------
Think great traders have an instinct to predict market movement better than everyone else? Think again. They trade on numbers and probability, not hunches.
In his book, Trend Following, Michael Covel states that trend followers have a philosophy that informs their trading. What is all too easy to miss is that these philosophies aren’t after-dinner digressions. When trend followers say they have a philosophy, they are talking about how they know the world around them, and this knowledge is not from books. It is won from the world and is quite empirical.
The trend-following philosophy can be summarized in seven statements – taken in part from actual utterances of trend followers (and the rest used with poetic license as regards their principles). Each will be covered in detail in the ensuing paragraphs. They are:
• No one can predict the future;
• If you can take the would-be, could-be, should-be out of life and look at what actually is, you have a big advantage over most human beings;
• What matters can be measured, so keep refining your measurements;
• You don’t need to know when something will happen to know that it will;
• Prices can only move up, down or sideways;
• Losses are a part of life; and
• There is only now.
The difference between trend followers and other types of traders isn’t one of style. What trend followers do is outside the scope of normal human reactions. Frankly, their deeply counterintuitive strategy should alert other traders that something very different is going on.
SIDEBAR
------------------------------------------
Ed Seykota’s Trading Tribe
Trend followers tend to be careful observers who notice trends everywhere; those observations include their own emotions while trading. Ed Seykota’s investigations of how trends in emotions affect trading first appeared in his now-famous interview in the original Market Wizards book. “Win or lose, everybody gets what they want from the market. Some people seem to like to lose, so they win by losing money.”
Over the last decade, Seykota has extended these apparently paradoxical insights into trading and life with another set of assertions; that we need to feel our feelings – those we like and especially those we don’t like. If we resist our feelings, we wind up creating “dramas” in our lives and in our trading so that we have to feel these feelings. As he puts it, “The feelings you are unwilling to feel are your real trading system.”
In many emotionally charged situations, like trading, a full expression of our feelings is stifled by an inner judgment about these feelings. Seykota calls this a “k-not.” Avoiding these k-nots becomes more important than any stated goal. The way to untie these k-nots is to experience the feelings, but because these are the feelings we are unwilling to feel, we need the support and acknowledgement of others. Seykota insists that traders need to band together in “Trading Tribes” where they can encourage each other to face, embrace and celebrate these feelings through a process known as the Trading Tribe Process (TTP®).
In TTP, a trader voluntarily takes the “hot seat” and other Tribe members encourage him. According to participants, when a trader feels his feelings fully, he often experiences an “a-ha” along with spontaneous insights and revisions of previously problematic trading behaviors.
Whether this sounds offbeat or on the money may depend on your attitude toward men’s groups, warrior training or something similar. You can find out for yourself through Seykota’s website:
http://www.tradingtribe.com
------------------------------------------
Take the adage every trader knows: “Cut your losses, let your profits run.” Clearly, every trader will agree that it is the hardest thing to do. Why? Is it because “a bird in the hand is worth two in the bush” (or in the account)? Or is it because when your dog runs away from home, he is usually back by dinner? Trend followers know about these experiences, and they know something else: They know that all of these examples are anecdotal. They are just personal experiences and beliefs that will bias their judgement. Trend followers know that these instances are not reliable guides to the nature of markets. All right then, what is?
No One Can Predict the Future
“There is no predicting anything,” the very successful trend follower, John W. Henry, tells us. What this means is that all of your hunches, intuitions and beliefs about how the world works are steeped in self-deception. Thus, despite pronouncements of a bunch of experts on television or elsewhere, tech stocks are not trading because of anything; gold is not moving for anybody. The Fed rate is not changing for a particular reason. It’s not that there are not market influences or market makers or reasons that markets change. There are. It’s just that there are so many of them. But to quantify them and to make a judgment about their relative weights and influences is beyond the possibility of anyone.
Trend follower and president of Dunn Capital, Bill Dunn, has a doctorate in theoretical physics. No one gets a doctorate in that discipline without understanding, in a deep way, the “three-body” problem. In the celestial version, Sir Isaac Newton found a way to mathematically describe the interaction of two bodies – the earth and the moon. To do this, he ignored all the other influences in the heavens. Enough for a start, he assumed his two-body solution would lead to solutions being found for the interaction of three, four and more. Two centuries later, they hadn’t. Finally, to speed things along, a prize was offered by the king of Sweden. It was won in 1889 by Henri Poincare, but not for solving it. He demonstrated that it could not be solved.
Professor Poincare found that with just three bodies, the behavior of each one affecting the other made it impossible to calculate directly what was going on, and therefore, how the bodies would affect each other. The same is true of the relationships between stocks, bonds and futures. Approximations are possible, but counterintuitively the more accurate that market participants try to make their models, the more these models cease to describe what is going on in the world.
The conclusion is, quite simply, that the world is much richer and more detailed than any model, and every model of complex behavior (starting with only three bodies) will fall short of a description that allows prediction. Was that too much detail? It turns out that trend followers are fascinated with the details of what is in the world and how it works. They live and work in the world of what is.
continued on part 2
It's Not What You Think. It's What You Know.
by: By Charles Faulkner
http://www.sfomag.com
-------------------------------------------------------------------------
Think great traders have an instinct to predict market movement better than everyone else? Think again. They trade on numbers and probability, not hunches.
In his book, Trend Following, Michael Covel states that trend followers have a philosophy that informs their trading. What is all too easy to miss is that these philosophies aren’t after-dinner digressions. When trend followers say they have a philosophy, they are talking about how they know the world around them, and this knowledge is not from books. It is won from the world and is quite empirical.
The trend-following philosophy can be summarized in seven statements – taken in part from actual utterances of trend followers (and the rest used with poetic license as regards their principles). Each will be covered in detail in the ensuing paragraphs. They are:
• No one can predict the future;
• If you can take the would-be, could-be, should-be out of life and look at what actually is, you have a big advantage over most human beings;
• What matters can be measured, so keep refining your measurements;
• You don’t need to know when something will happen to know that it will;
• Prices can only move up, down or sideways;
• Losses are a part of life; and
• There is only now.
The difference between trend followers and other types of traders isn’t one of style. What trend followers do is outside the scope of normal human reactions. Frankly, their deeply counterintuitive strategy should alert other traders that something very different is going on.
SIDEBAR
------------------------------------------
Ed Seykota’s Trading Tribe
Trend followers tend to be careful observers who notice trends everywhere; those observations include their own emotions while trading. Ed Seykota’s investigations of how trends in emotions affect trading first appeared in his now-famous interview in the original Market Wizards book. “Win or lose, everybody gets what they want from the market. Some people seem to like to lose, so they win by losing money.”
Over the last decade, Seykota has extended these apparently paradoxical insights into trading and life with another set of assertions; that we need to feel our feelings – those we like and especially those we don’t like. If we resist our feelings, we wind up creating “dramas” in our lives and in our trading so that we have to feel these feelings. As he puts it, “The feelings you are unwilling to feel are your real trading system.”
In many emotionally charged situations, like trading, a full expression of our feelings is stifled by an inner judgment about these feelings. Seykota calls this a “k-not.” Avoiding these k-nots becomes more important than any stated goal. The way to untie these k-nots is to experience the feelings, but because these are the feelings we are unwilling to feel, we need the support and acknowledgement of others. Seykota insists that traders need to band together in “Trading Tribes” where they can encourage each other to face, embrace and celebrate these feelings through a process known as the Trading Tribe Process (TTP®).
In TTP, a trader voluntarily takes the “hot seat” and other Tribe members encourage him. According to participants, when a trader feels his feelings fully, he often experiences an “a-ha” along with spontaneous insights and revisions of previously problematic trading behaviors.
Whether this sounds offbeat or on the money may depend on your attitude toward men’s groups, warrior training or something similar. You can find out for yourself through Seykota’s website:
http://www.tradingtribe.com
------------------------------------------
Take the adage every trader knows: “Cut your losses, let your profits run.” Clearly, every trader will agree that it is the hardest thing to do. Why? Is it because “a bird in the hand is worth two in the bush” (or in the account)? Or is it because when your dog runs away from home, he is usually back by dinner? Trend followers know about these experiences, and they know something else: They know that all of these examples are anecdotal. They are just personal experiences and beliefs that will bias their judgement. Trend followers know that these instances are not reliable guides to the nature of markets. All right then, what is?
No One Can Predict the Future
“There is no predicting anything,” the very successful trend follower, John W. Henry, tells us. What this means is that all of your hunches, intuitions and beliefs about how the world works are steeped in self-deception. Thus, despite pronouncements of a bunch of experts on television or elsewhere, tech stocks are not trading because of anything; gold is not moving for anybody. The Fed rate is not changing for a particular reason. It’s not that there are not market influences or market makers or reasons that markets change. There are. It’s just that there are so many of them. But to quantify them and to make a judgment about their relative weights and influences is beyond the possibility of anyone.
Trend follower and president of Dunn Capital, Bill Dunn, has a doctorate in theoretical physics. No one gets a doctorate in that discipline without understanding, in a deep way, the “three-body” problem. In the celestial version, Sir Isaac Newton found a way to mathematically describe the interaction of two bodies – the earth and the moon. To do this, he ignored all the other influences in the heavens. Enough for a start, he assumed his two-body solution would lead to solutions being found for the interaction of three, four and more. Two centuries later, they hadn’t. Finally, to speed things along, a prize was offered by the king of Sweden. It was won in 1889 by Henri Poincare, but not for solving it. He demonstrated that it could not be solved.
Professor Poincare found that with just three bodies, the behavior of each one affecting the other made it impossible to calculate directly what was going on, and therefore, how the bodies would affect each other. The same is true of the relationships between stocks, bonds and futures. Approximations are possible, but counterintuitively the more accurate that market participants try to make their models, the more these models cease to describe what is going on in the world.
The conclusion is, quite simply, that the world is much richer and more detailed than any model, and every model of complex behavior (starting with only three bodies) will fall short of a description that allows prediction. Was that too much detail? It turns out that trend followers are fascinated with the details of what is in the world and how it works. They live and work in the world of what is.
continued on part 2