This review is unlikely to make me friends, and likely to generate some negative mail.? Let me start with the conclusion: don’t buy the book.? That said, my reasons for stating this are different from those who typically criticize Michael Covel.? I agree with much of what he says; I disagree with much of his rhetoric.? Let me give you my thoughts:
1) Momentum is a pervasive factor in the markets.? It works about 80% of the time and produces significant excess returns on average.? Behavioral finance points out that people are slow to adapt to new information, so momentum tends to work because the initial moves on new information aren’t sufficient.? That said, when too many are chasing momentum, the market becomes extremely volatile, and the strategy ceases to work, until it shakes out enough momentum-followers.
What is hard, is distinguishing trend following from technical analysis from momentum.? Personally, I think momentum explains the other two.? It’s a much simpler theory, and much as Covel appeals to Occam’s Razor, I apply it back to him here.
2) He draws on a series of investors that have done well in the past, and touts them as proof of his theories.? Hindsight is 20/20.? What of those that have tried to apply trend following and failed?? Is it many or few?? Keeping a tight stop loss for some means the death of a thousand cuts.? The studies that I have seen show that frequency of trading tends to decrease returns.? Now, trend following does not necessarily mean a lot of trading, but for many it ends up being that way.
It is easy to locate a bunch of trend followers in hindsight, and tout their abilities.? What would be harder would be to find the whole universe of people following trends, and see how they do as a whole.
3) Mean reversion is a weaker factor, but still significant in making money.? Value investors typically do well with it, but only reliably when they insist on strong balance sheets.? I’ve studied mean reversion for years, and it exists in almost all markets as a weak factor.? Over enough time, that weak factor has punch, but in the short run, momentum rules on average.
4) Covel spends a lot of time trashing fundamental analysis, without much meat behind it.? Fundamental analysis works well, but doesn’t have so much value because so many are applying it.? It’s not like the situation Ben Graham found, where few were doing it.
Aside from that, technicians implicitly rely on fundamental analysis, because their support and resistance levels stem from the decisions of fundamental investors.? Same for those that follow trends.? The trends exist because fundamental investors react slowly to changes in the fundamentals, and trend followers exploit them.
5) There is no mention of the Adaptive Markets Hypothesis, and little discussion of Behavioral Finance.? These are much richer theories that encompass “trend following.”
6) Covel takes “pot shots” at Buffett over issues that are unrelated to his main point in an effort to discredit him.? Buffett is a bright guy who can criticize derivatives in aggregate, while still using them in specific to his advantage.? (Cough, cough.? Please ignore his put option trades.)
7) There was not enough time spent on “how to trend follow.”? After reading the book, if I didn’t have prior background knowledge, I would be scratching my head to figure out how I could reliably pick investments in a trend following mode in order to make significant excess profits, as well as know where to sell them.
I don’t recommend it, but you can buy it here: Trend Following (Updated Edition): Learn to Make Millions in Up or Down Markets
Final note — Covel needs to grow up and learn that there are other factors in the market aside from momentum.? He has become a fundamentalist about “trend following” and does not seem to have the open mind that he harps about.
PS ? Remember, I don?t have a tip jar, but I do do book reviews.? If you enter Amazon through a link on my site and buy things from them, I get a small commission, and you don?t pay anything extra.? Such a deal if you wanted to get it anyway?
Great book review, I agree with you 100%
I will simply ask you–Is the goal to be “right” or to make money when investing?
Both. You make money when you are right. That includes risk control which I am big on. Losses are part of the game. My methods are designed to minimize the effects of errors, though I fail often enough.
Covel should spend more time on the behavioral finance literature, study the anomalies, and then tell me — how is trend following different from momentum? I am a value investor that uses momentum positively in investing. It works, marrying a long run factor and a short run factor.
I agree. There is, however, an economic basis for trend following techniques, see my take here: http://humblestudentofthemarkets.blogspot.com/2008/11/trend-following-ctas-no-panacea.html
Bridgewater did a study years ago showing that you can replicate trend following programs at minimal cost using passive techniques. Here is another academic study showing the same thing: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1279594
“Trend Following” is a subject that the vast majority of investors have never heard of — even though track records showing its success go back decades across many traders (not just one icon as in the fundamental world). That said David, I am willing to consider your “marrying a long run factor and a short run factor” investing style. Keeping with the spirit of my book, a book backed by audited performance records month by month, where can I find the performance records of this style you speak of?
Thanks to all of the above for the discussion. very helpful
I find the amount of time people will spend arguing about trading or investing styles rather odd. I can only surmise the reason people do this is to facilitate the sale of their particular style to the public.
If you have a style or plan that works well for you I would think you may just want to keep it to yourself.
Unless of course you are a true humanitarian and you feel compelled to “give” your great gift to all mankind.
But then if it is a gift you wouldn?t have to defend it.
Most of the head-slapping, “why didn’t I take advantage of that?” recognition of trends occurs in hindsight.
It is the power of this backward-looking recognition in the human mind that compels us to then look forward to then try to discover trends in progress, and thus exploit this seemingly obvious and easy path to financial gain. This appearance of obviousness is an illusion.
Before you can follow a trend, you must be able to determine that a trend exists and that it is actually in progress at the present moment. Is it possible to make this determination with any certainty?
Sadly, there is no way to absolutely assure oneself that a directional move in the market will continue for any period of time. One cannot even develop a reliable relative measure of the success of a real-time trend determination methodology without the necessary data. How many of these datasets exist?
There may be trend-seeking investors who feel that they possess a methodology that permits to detect when a current market swing is in fact part of a trend and when it is not, but the “proof” of their ability to actually do this would require a valid sized sampling of their trades, cataloged over a sufficient amount of time to permit development of statistical measures of the magnitude and the significance of their outperformance. And this still wouldn’t prove anything about the future outcomes of using this method for real-time trend identification.
Even with an ourperforming method, how could the outside observer attribute the source of the outperformance to the trend-following investment philosophy?
Let’s say you look back and see that a trend has occurred in the past. How can you determine the causal factors that brought about the trend in the first place? If you could determine the factors that precipitated the trend, how can you be assured that the same factors occurring in the future in a different market would generate the same buying and selling responses that created the prior trend?
Most portfolio-based trend exploiting methods try to overcome these murky questions with diversification.
My take is that seeking trends in the market and talking about trend following is a form of a faith-based activity.
If you have an unshakable belief that trends exist (because you have seen that they occurred in the past), and you believe that you can detect when a specific market swing is in fact part of a trend and when it is not, then that belief by itself and the confidence that it engenders in the investor is the major benefit that results.
Tradahmike, why are you concerned with determining “the causal factors that brought about the trend in the first place?” Why does that help to trade as a technical trend follower?
Michael,
Not really sure if I can speak for Tradahmike, but I’m in agreement with him – it’s a question of replicability, and being able to determine that there’s actually “something there” making the whole trend-following process work.
Put another way, the stock market is a black box; we see only the output (price changes). Understanding causal factors ensures us that there is some logic to the black box, and that we’re doing something more than throwing darts randomly.
Very good comment James
Michael, thanks for your reply.
The reason that determining “the causal factors that brought about the trend in the first” is important is that without the identifying the underlying engines of trend causation, there is no way to differentiate between current market swings that turn into trends and current market swings that fail and turn into consolidations or reversals.
Consider all the millions of investment vehicles that trade every day. Each one of them is in the process of developing its own price discovery, creating a trail of price movement that we can chart and observe in hindsight.
Some of these price charts would show instruments in narrow sideways consolidations. Some would show instruments in more volatile, trendless chop. Some would show instruments in robust directional moves, either up or down.
What does any of these visible price histories alone tell about the probabilities of any one of these individual instruments developing an exploitable trend of the type that you posit investors should seek out? In my opinion, nothing.
Without identifying a set of underlying trend-generating phenomena, past price action alone tells you nothing about whether a current price swing will become a trend or not. The trends are only visible after they are well developed or completed, and jumping on a already-developed trend structure provides no additional margin of safety against suffering an immediate price reversal.
Looking at the charts of past trends, however, does create a powerful implication to the human mind that this type of past trending behavior in the markets can be identified and exploited in real time. My contention is that current price swings that will later become the trends that we observe in hindsight cannot be differentiated in real time from the market swings that do not ultimately develop into trends.
If investors wanted to attempt to capture trending behavior without trying to determine whether a trend was in progress or not, simply leave a partial position of an already successful trade in the market to run wherever the market takes it.
Eventually, some of these positions would participate in significant market trends. But you could only see the trend structure in hindsight, and you would still not know when the trends had ended, even if you rode the entire thing profitably.
Just my 2 cents, thanks.
Thanks Tradahmike for the clarification, but you do realize the traders who practice trend following as I describe in my book do not identify the underlying engines of trend causation? Their performance track records, often going back decades, were not generated as you describe. To me it seems there are many conversations going on here, and many views, but it doesn’t seem like trend following as described in my book is clearly grasped across the board. Fundamentals are not used by trend followers — they trade price action.
James and Paul, trend following traders don’t have black boxes (whatever that means exactly). They know exactly when they will buy and sell along with how much they will bet on each trade before they ever enter. How is that black box? I don’t care if folks say trend following as I describe doesn’t work, or don’t like the strategy, etc., but it seems like here in this thread it is simply not understood.