Probable Outcomes by Ed Easterling

Posted by Mike Shell on July 05, 2011

This is the book you've got to read to understand longer term (secular) price trends and why it's crucial to pursue active risk management and absolute return strategies. It's why we do what we do.

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It is uncommon for research of this caliber to be shared with the world. I wrote a review on Easterling's first book "Unexpected Returns" in 2005, which is absolutely essential reading for all investors. In fact, we've long since given copies to our investors to read and I've used it for training other portfolio managers. Probable Outcomes is kind of a sequel to Unexpected Returns and once again: it's an essential update. It's crucial for investors to understand the state of the long term trends. Easterling warned in his 2005 book: passive buy and hold strategies are likely to cause pain to your wallet. And it did. Eastlerling provides the likely course for the stock market this decade giving investors well informed expectations. I strongly recommend it so you understand the possibilities and why it's crucial to pursue active risk management and tactics to row, not sail. The history already speaks for itself for those who were prepared. What I said in the 2005 Amazon.com review of Unexpected Returns still holds true today and is probably more obvious:

Traditional "buy and hold" relative return strategies rely on the direction of the markets. They enjoy gains when they occur, suffer loses when the market declines, and require a long time horizon that many investors don't have. Skill-based tactical strategies seek gains regardless of market direction using investment manager skill in sector rotation, hedging strategies, and risk management. As Ed says in the book, when the wind is blowing we can let out the sails and enjoy the ride. When the wind stops blowing, you can sit there and wait for the wind to come again, or you can get out the oars and start rowing. Based on current technical and fundamental research, it seems the wind may not cast our sails and the oars are now necessary to get where we want to go.

Trend Commandments by Michael Covel

Posted by Mike Shell on June 30, 2011

I just finished reading Michael Covel's latest book Trend Commandments and it's a great follow up to his previous books. Mike is also the author of two outstanding books written about trend following: Trend Following and The Complete Turtle Trader. I've read more than 500 portfolio management/trading books that I've ordered from Amazon alone, so I can tell you Covel's are strong trending outliers. Trend Commandments is a collection of essential beliefs shared by systematic trend followers, including myself. It was nice to see "Mike Shell" in the acknowledgements. If you pursue an asymmetric risk/reward profile: a positive mathematical expectation where profits are imbalanced over losses, Covel's trend following writings are the right direction. Once you get in the right direction, keep going...

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Source: www.michaelcovel.com 

Here is a glimpe of what you'll find in the book (from the "Cheat Sheet" in the back):

Profit in up and down markets: Trend following doesn’t swear an allegiance to a bull or bear market. It follows trends to the end. No matter how ridiculous trends might appear early and no matter how insanely extended they might appear at the end, follow trends. Why? They always go farther than anyone expects. Ignore momentum at your peril.

No more buy and hold, analysts, or news: Trend following decision-making doesn’t involve discretion, guesses, gut feelings, or hunches. It’s not day trading or buy and hope. It doesn’t involve passive indexing, in and out trading, or fundamental analysis. No more 24-hour news cycles, daily turbulence, or sensational hype. No black boxes or magic formulas either. Let go of the Holy Grails.

No prediction: Trends exist everywhere, always coming and always going. Markets are no different: They trend up and down. That said, no one can predict a market trend, you can only react to one. Trend following never anticipates the beginning or end of a trend. It only acts when the trend changes. There is no need to figure out why a market is trending, just follow it. You don’t need to understand electricity to use it.

The big money of letting profits run: Trend following at its best aims to compound absolute returns. It doesn't shoot for average. The goal is to make the knock your socks off returns, not passbook savings interest. Trend following also has the unique ability to lie and wait for targets of opportunity. That means making a killing on unpredictable surprises.

Risk management is top priority: Trend following always has defined exit protocols to control injury to your account. Stop losses and proper leverage usage are standard practice. Trend following also has low to negative correlations with most other investment opportunities.

Takes advantage of mass psychology: Trend following takes advantage of panicky sheep behavior. Strict discipline minimizes behavioral biases. It solves the eagerness to realize gains and reluctance to crystallize losses. Too many people believe what pleases them. Most behaviors are simply driven by the impulsive moment of now. Trend following wins because of that.

Scientific approach to trading: Trend following doesn’t require a belief, but rather it relies on unwavering scientific principles. It has a defined edge just like the MIT card-counting team that beat Vegas casinos. Be the casino, not the hapless player. Trend following uses rigid rules rooted in numbers. Think process not outcome. Remember, frequency of correctness is not the issue, the magnitude of correctness matters. Winning percentage means zilch.

Strong historical performance in crisis periods: Trend following is adaptable to differing climates and environments performing best during periods of rising volatility and uncertainty. The unknown will happen again. Are you ready? You have to be able to ride the bucking bronco. Ride out the storm and stay alive.

No traditional diversification: Trend following is not restricted to any single market or instrument. A focus on price action allows trend following to be applied to an exceptionally large variety of markets. Price is the one thing that all markets have in common. A trend trading system for Treasury Bonds should also work on the Euro and stocks. Trend following is robust.

No government reliance: Forget Social Security, bailouts, stimulus plans, and roads to nowhere. Those won’t help you to make money; they only help you lose. When the Fed puts on or takes off the training wheels (read: rate manipulation), will you be ready to mint cash or will you sit there and just take it again? If your portfolio is grounded in sound principles, you can win no matter what happens. 

Source: Covel, Michael W. (2011). Trend Commandments: Trading for Exceptional Returns, FT Press.