Tuesday, December 06, 2005

Chris "Piranha" on trading, and me on trend following fables

One of my trading mentors, Chris at marketstockwatch.com has addressed an important question for traders: whether it is better to ride long trends or short ones? Here is a link to his discussion.

Chris has experimented for years with both short term trading and long term trading and describes his preference, "I am looking for the big, long term moves, not the short quick gains. The big moves make you rich, not the quick little gains; they make you impatient and hesitant. Patience is the key to success if you want to make the big bucks on Wall Street." This position is familiar to people who have read my all-time favorite book, Reminiscences of a Stock Operator.

Unfortunately, long-term trend following is one of those things that is much easier to say than to do, as anybody who has tried can attest. I love all the long-term trend following fables that great traders tell each other for strength. Reminiscences of a Stock Operator has plenty of them in it, one of the more memorable ones is about "old man Partridge". The entire book itself is even a trend following fable! The trenders blog linked on my blogroll had a great one a couple weeks ago, this zen story has popped into my head countless times since I read it. Ed Seykota tells a memorable one about a jademaster and student in his book The Trader's Window. Jack Schwager liked it enough to include it as a prologue to his The New Market Wizards book. Michael Covel, author of Trend Following covers all kinds of great trend following fables, which leads me to one of my own. People who know me are going to laugh at this one if I haven't already told them!

When I first opened a forex account I tried to trade the same patterns on the EUR/USD that I do in stocks. I don't do that anymore, and when I first realized it wasn't going to work, I noticed something else. I saw that when the price deviated much from its average, there was a very high percentage chance that it would revisit its average price again, and even swing past it on momentum. In fact, it would revisit almost ANY price! So I put on a small position, and when it went against me, I averaged down into it. When it kept going, I averaged down again. As the price revisited each level where I had added to it, I took some of my position back off, so that when it reached my original entry, I had the original position, only I had slightly reduced my cost basis. A little bit more movement in my direction would cause me to close the trade at a respectable profit. I would never have dared to trade stocks this way, and I knew what I was doing was wrong, but I did it anyway.

Well a couple days later, the inevitable happened, the trade didn't come back my way and my loss was snowballing. I happened to be doing some reading while I was babysitting my currency position because it was getting very late but I was stuck at the computer to finish this trade. Maybe you can guess what I was reading. I thought, "I wonder what Victor Neiderhoffer would do? He was in a jam like this in the beginning of his book The Education of a Speculator." Now, mean reversion works for some people, but when they blow their tops, it is spectacular. Victor's demise being an example discussed in Michael Covel's book. So I'm reading Victor's yen trading story while I've got this loss is snowballing out of control and I had a moment of clarity. Averaging down like I was doing is destructive behavior. John Maynard Keynes may as well have been standing right beside me with a chalk board chanting, "Markets Can Remain Irrational Longer Than You Can Remain Solvent. Write it one hundred times and think about what you've done." I was lucky to be trading small enough when that happened that my large loss in currency was smaller than an average loss in stocks for me at that time.

I guess mine wasn't much of a fable, more of a trading sin confession, but the lesson is relevant. And I wanted to be in bed an hour ago so I'm through here for now :D

P.S. I respect Victor as a trader, and I mean no disrespect with this post. Vic, you're a legend and I like your books!

2 Comments:

At 6:48 AM, Blogger Chris Perruna said...

Jon,
Interesting post and I agree with what you say:
“Unfortunately, long-term trend following is one of those things that is much easier to say than to do, as anybody who has tried can attest.”

I tried to make it very clear that long term trend following is very difficult because sticking with a stock that is correcting is virtually impossible when it starts triggering mental or physical stop protections. Many traders find stocks that can and do move 100% but they aren’t in the position throughout the entire run, I am very much included in this bunch:

“It is very hard to find stocks that go up 100% and actually have them in your portfolio the entire time through all dips and corrections.”

Keep up the good work!
-Chris

 
At 12:17 PM, Anonymous Anonymous said...

"Markets Can Remain Irrational Longer Than You Can Remain Solvent"

Nice site, great content...I'll be hanging around for a while.

 

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