John Henry's Trading Philosophy

John Henry discusses his trading system design philosophy here. Henry discusses the time period in which he developed his original trend-following system. And offers some great insights such as...

Every time we go through a bad period in our firm, whether it's for two months or for eight months, people ask me have the markets changed. And I always say the same thing. I say, "Yes, the markets are always changing; but people's reaction to change, more or less, remain the same."

I knew I could not predict anything, and that is why we decided to follow trends, and that is why we've been so successful. We simply follow trends. No matter how ridiculous those trends appear to be at the beginning, and no matter how extended or how irrational they seem at the end, we follow trends.

At JWH, we realize that not only is it impossible to foretell the future, it's not necessary. We rely on the fact that other investors are convinced that they can predict the future, and I believe that's where our profits come from.

We may take a small risk in placing a trade initially, but after we have a large profit we risk it, and that's a risk very much worth taking and one we gladly accept.

Suffice it to say that we embrace both volatility and risk and, for us, risk is that we're going to lose if we risk two-tenths of one percent on a particular trade. That is, to us, real risk. Giving back a profit to you probably seems like risk, to us it seems like volatility.

Enjoy the article.

Later Trades,

MT

Interview with the Stock Bandit

Check out this really nice interview with Jeff White over on the Stocktickr blog. Read the interview here.

I like his KISS principles and the fact he doesn't look for the market to do this or that...just takes what the markets brings to him via his setups. Nice.

MT

Quote of the Week

"In fact, the ironic part of system design is if you want to maximize profits, you must be willing to give back a great deal of the profits you have already accumulated." -- Van K. Tharp

There is a fine line between giving away too much of your profits and giving too little room for your positions to grow.

Later Trades,

MT

Quote of the Week

The Six Kase Behavioral Laws of Forecasting

Law Number One: Remember that the objective is profit, not ego-stroking.

Law Number Two: The objective is profitable trading, not proving a thesis or world view.

Law Number Three: When wrong, move on.

Law Number Four: Have confidence in your own intuition. Do not rely on the advice or opinion of others, no matter how well respected they might be.

Law Number Five: Do not read newspaper articles or watch newscasts that discuss the markets in which you have an interest.

Law Number Six: Plan your strategy when the market is closed - when you are rested and thinking clearly.

The above Quote of the Week comes from a new book I'm reading...Trading With The Odds: Using the Power of Probability to Profit in the Futures Market by Cynthia A. Kase.

No doubt, one of the all-time best books I've read on Trading...but I'll warn you...for the experienced system trader only. In other words, I would not have understood many of the fantastic insights offered in this book just a few short years ago.

In fact, while reading this book I was struck with how incredibly difficult it is to become a great system trader. Flourishing as a system trader requires two very different and conflicting mindsets:

#1) A Rule-Follower. Must be a logical thinker willing to break down the most complex of things into a set of rules to follow. And more importantly, be willing to follow the rules you have set. The latter being the hardest part for yours truly.

#2) A Rule-Breaker. In order to grow to higher levels in system trading...you must be willing to break conventional wisdom [rules] in regard to all things people including yourself take for granted. And this where the conflicting mindsets truly come into play. It's very hard to program a set of rules for a system and then allow yourself to see the ways rules can be broken to improve the system. Sounds easy...but very hard. Thinking about this one some more...I believe our true task as a trader is discovering the "real" rules versus the rules we traders have created and hold as "real".

That's what I believe Kase is uncovering in her book...the "real" rules.

Special thanks to Eric for pointing out the Variance Stop technique discussed in Kase's book. Eric's contribution has triggered several exit ideas that I'm currently testing across my systems.

Later Trades,

MT

Nassim Taleb Highlights

Active Trader Magazine interviews Nassim Taleb in the March issue. Here's a few items that Nassim shared:

If you owned an option that was 20 standard deviations out of the money - and I had plenty of those - how many cumulative months of time decay could you sustain if it moved into the money?...it was 67,000 months of time decay.

If you have a 24-sigma even on an option that's 24 standard deviations out of the money, your payoff is 750,000 times your bet.

We're not programmed to deal with variables that can take very large deviations. We tend to not pay at all for things when we don't have reason to pay for them, but overpay when we see a reason.

There's a bit more but for that you'll have to get the magazine. :)

I realize I haven't gone back to the Melba Toast system in quite awhile...it hasn't been forgotten...just been extremely busy. But there is good news...I have made some progress in capturing the dry toast pattern. At first I thought I'd have to use a bit of trig to capture the exact pattern...but from the initial tests it looks like a max/min range divided by ATR might do the trick. Hopefully, I'll get a chance to test this piece out soon and share the results with ya'll.

Until then...

MT

Quote of the Week & Robert Pardo Interview

"Being a scientist can sometimes be depressing. Surrounded by younger versions of yourself, you are constantly confronted by the mismatch between the dreams of youth and the facts of maturity." -- Emanuel Derman, author of My Life as a Quant

One of my favorite quotes and not only applicable to scientists and programmers...but everyone with several years of experience under their belts...and perhaps a few gray hairs to show for it. Heck, even relates to being a parent. Universal theme...I love it!

On to other things...this weekend I found a great interview with Robert Pardo, the author of Design, Testing, and Optimization of Trading Systems. Read the interview here. Some quick highlights:

When I first started getting into systems, I was persistent, objective, and analytical. I've always been willing to say what it is that I do know, and what it is that I don't know. If somebody said to me "this will work" I'd say, "well, why will it work?" What's the proof?"
Great thinking...I believe many of us could apply this type of thinking to our investing strategies.

And Pardo goes on to describe the great Art of Cherry Picking...
They call this sort of thing cherry picking now. So many people, when they're looking at an idea by hand will say, "oh, it worked here, it worked here, it worked there, and boy, did it work great!" They ignore the fact that it had seven losers before this big win, and three more losers before that big win. They're maybe small, but they do add up. They need to be included in the equation.

In a system, risk is uniform and constant. I re-optimize models periodically because conditions and volatility change. You have to adapt to that to get optimal returns. Generally, though, we're risking the same tomorrow that we are today. Most people not only will vary their risk a great deal, but they'll get very skittish when they actually get a profit.
There's a powerful strategy being expressed here. Something Basso mentioned in his Market Wizards interview.

Overall, a great interview and piques my curiosity as to the other interviews covered in the Market Beaters book. I guess another book to buy and read. :)

Also, don't forget...the new issue of Active Trader Magazine contains an interview of Nassim Taleb. Just bought the mag this weekend. So, I'll share some highlights of the interview sometime this week.

Later Trades,

MT

TGIF

Some great quotes from acrary over on the EliteTrader Forum.

"Trading cannot be taught...it has to be caught. By that I mean you must have a perceptive nature. Without it, buy a system and execute it mechanically."

"I've had experience with this problem (self-sabotage). In short, I found if I had a goal that my self-concious believed was not doable, then I'd self-sabotage my trading. Once I realized this and changed my goals, the self-sabotage stopped."

"If you want to remain emotionless during trading, concentrate on the process and let the outcome happen."
** my favorite one **

Now, for some silly Friday quotes...

"Giant oaks do grow from little acorns. But first you must have an acorn."

"Behind every successful man stands a surprised mother-in-law." -- Hubert Humphrey

"Always program as if the person who will be maintaining your program is a violent psychopath that knows where you live." -- Martin Golding

"As soon as we started programming, we found to our surprise that it wasn't as easy to get programs right as we had thought. Debugging had to be discovered. I can remember the exact instant when I realized that a large part of my life from then on was going to be spent in finding mistakes in my own programs." -- Maurice Wilkes

And finally, the always funny Jack Handy...

He was a cowboy, mister, and he loved the land. He loved it so much he made a woman out of dirt and married her. But when he kissed her, she disintegrated. Later, at the funeral, when the preacher said, "Dust to dust," some people laughed, and the cowboy shot them. At his hanging, he told the others, "I'll be waiting for you in heaven--with a gun."

Enjoy your weekend!

MT

Does Trend Following Work on Stocks?

Check out this paper written by Eric Crittenden and Cole Wilcox of Blackstar Funds: Does Trend Following Work on Stocks? There's a lot of great information embedded in this paper. And for equity system traders...much to learn. In fact, so much to learn, that I've exchanged a few emails with one of the coauthors, Eric Crittenden. Before I begin...let it be said that Eric is a very sharp guy and truly understands the system trading world.

One of the great things I found in this paper was finally someone addressed survivorship bias in their system tests. And more importantly discussed the impact of dividend-adjustments. The really surprising point, especially after talking with Eric, was that survivorship-bias doesn't play as much of a role as I thought in backtesting long-term stock trading systems and dividend-adjusted data or lack thereof plays a much larger role than I expected. So much of a role that my first goal after reading the paper and talking with Eric is to obtain dividend-adjusted equities data.

Another dividend, if you will, of dividend-adjusted data is that your system signal's can be applied to a different time series despite the underlying stocks remaining the same. In other words, you may get more trades if you run your system against two sets of data...1) Non dividend-adjusted and 2) Dividend Adjusted. Some stocks that previously looked stale or non-trending may indeed show up in a long-term trending system with dividends factored in.

Re-entry of positions is another very interesting part of this paper. In my current systems I do not have re-entry criteria. If my trailing exit is hit...I'm out of that stock for good...or until my system model captures it again. In the paper you will see stock charts with stocks hitting the ATR trailing stop and then re-entered. This also has made me look to my own systems and possibly adding some type of re-entry logic.

And finally, for those still yearning for more Trailing Stop ideas...the paper provides plenty of discussion on the Average True Range trailing stop technique. Eric has even offered an alternative solution to the ATR trailing exit problem from my Innovating Exits post. His solution involves using the variance of the Average True Range in your trailing stop. I'll discuss more on this in another post.

Finally, I'd like to express my thanks to Eric for kindly responding to my questions and graciously sharing his thoughts and views on system trading. Maybe I can get an interview out of him to share on the site some day.

Until then...

Later Trades,

MT

Quote of the Week

"The whole problem with the world is that fools and fanatics are always so certain of themselves, but wiser people so full of doubts." -- Bertrand Russell

MT

Quote of the Week

"Any time you sincerely want to make a change, the first thing you must do is to raise your standards. When people ask me what really changed my life eight years ago, I tell them that absolutely the most important thing was changing what I demanded of myself. I wrote down all the things I would no longer accept in my life, all the things I would no longer tolerate, and all the things that I aspired to becoming." -- Anthony Robbins

MT

CXOAG System Linkfest!

Did a little digging on CXOAG's blog and found some interesting studies they've performed on the market. Enjoy!

Collective2: A Marketplace of Trading Systems
Culls through the number of systems in Collective2's site and breakdowns the performance of swing trading versus daytrading. Most interesting part? Only 24% of Collective2's systems average 1% or more per week yet all systems exceed winning percentages of 50%.

Update: Cramer Offers You His Protection?
Asks and answers the question, Does Cramer have an edge? Insights shared: There may be some edge in buying the Cramers sells during the immediate negative returns and holding longer than 6 months. And it seems part of Cramer's edge is issuing buys on a rather large number of stocks. This creates a thin red line where the more stocks issued as buys...take him further away from market beating returns.

End-of-Quarter Effect: Window Undressing?
Is there a tradeable event at the end of quarters? This is something I have tested in the past and my results match their findings...expect market strength after the quarter...not before.

A Slinky (Short-term Reversion) Effect?
A study is performed on the cane walkers of Wall Street. After reading this post...I thought why judge the decline absolutely? Judge against volatility instead?

An Out-of-Sample Test
Discusses James O'Shaughnessy's strategies now used by Hennessy Funds. Interesting the Growth strategy beat Value in out-of-sample testing.

Later Trades,

MT

Over My Head...

The article titled, The Use of Hurst and Effective Return in Investing by Andrew Clark, contains much that is over my head. But, that shouldn't dissuade me or you from diving in and learning what we can. Heck, any article that contains the following statement is definitely worth my time...

Ideally, a good performance measure should show high performance when the return on capital is high, when the equity/return curve increases linearly over time, and when loss periods (if any) are not clustered.

In the sentence above, Andrew Clark describes just exactly what all of us are looking for in designing, testing, and evaluating our trading systems.

Sorry for the lack of updates on the Melba Toast System. I've been very busy with other projects. But, haven't stopped dreaming up ways to capture the congestion. Here are just a few ideas that I will test as soon as I get the time:

• What if you count the number of weeks a stock closes above its mean and number of weeks closed below its mean? If the ratio of above to below is close to 1 then does that suggest a congestion range-bound area in the time series?



• Should we look for these congestion areas within a certain percentage from their all-time high? Or all-time low? Or both? Or maybe all-time high is too limited and we just need to look for a certain percentage from their 5-year high and low.



• Could using a stock's beta help identify congestion areas? Does the congestion area exhibit less beta than the market? Speaking of beta...has anyone ever attempted to create an indicator out of beta? Basically, the number of stocks with a beta above 1? If so, please share.

Well, that's it from here...where I'm looking forward to seeing Ricky Bobby on the big screen! Ha ha!

Later Trades,

MT

Quote of the Week

"I'm not smart, but I like to observe. Millions saw the apple fall, but Newton was the one who asked why." -- Bernard M. Baruch

Observation is important but the true key is the ability to open your mind to new possibilities. Without an open mind...you cannot see all that's possible.

Have a great week!

MT

Melba Toast Examples

This page will showcase all stocks that I find exhibiting the Essence of Melba Toast. The more examples I can find of Melba Toast...the better chance I have of identifying the logical conditions present in the pattern. So, this page will evolve as new charts are added.







MT

Quote of the Week

"No question is so difficult to answer as that to which the answer is obvious." -- George Bernard Shaw

Have a great week!

MT

Tom Basso Interview

I haven't fallen off the face of the earth. But, have been extremely busy at my day job. I'm also busy testing various ways to capture the sideways congestion in Melba Toast. The initial rules work to some extent...but after further tests...still don't capture the exact model I'm looking for.

So, I've decided I've got to go old school and start collecting charts of all the sideways congestion examples I'm looking for. I'm going to create a page on the blog and store the charts there. That way I can spend more time checking out the specifics of the moves. And hopefully find a way to logically explain the pattern I'm looking for. I'll post a link to this page in the next few days.

Until then, check out this great little interview of Tom Basso. Read the pdf here. Basso is one of my favorite fund managers in the Market Wizards book series. And in this interview Basso shares some gems.

Back-testing can be useful, but I recommend you go one more step. Print out the gory details.

I look for an indication that a trend either exists or doesn't. I like to look for those markets that aren't currently trending, the ones nobody cares about. Those are the markets that are likely to make a move one way or another.

If you mismatch what you're trying to do to who you are and what skills and resources you have, you're always going to be fighting it and never be in sync with it. If, on the other hand, you match your trading system to yourself, then trading can become as easy as breathing.

And don't miss Basso's famous money management test on a random selection of trades. Profits to losses were setup as a two-to-one ratio and the buys and sells were fed back randomly. The tests showed professionals focused on risk while amateurs focused on gain. Something to think about.

MT

Quote of the Week - Cowboy Up!

"If you're ridin' ahead of the herd, take a look back every now and then to make sure it's still there with ya."

We are so busy blazing our own path through the markets. We often forget what really matters...equity performance. Our job is to wrastle that equity to higher ground. All the talk, debate, yip-yap, and how often you're right isn't worth the bucket it sits on...if your equity isn't still there with ya!

Later Trades,

MT

Melba Toast - First Test

If you've read my first post on the system idea of Melba Toast...then you're probably wondering just how that simple little idea performed in market history. Now, remember...all we did was apply a few simple filters. We haven't gotten our hands dirty yet. That happens when we start focusing on patterns. And thanks to Damian for his pattern idea submission...which we'll be sure to use when we get to that point.

Now, when I get a rough set of filters built...I'll usually start looking for stocks that I want to pick up in the system. I do in this in two ways. The first is by using stocks that I've experienced the idea I'm trying to develop with. And I shared those with you in the first post. The second thing I do is run a quick backtest on a small subsection of the market to see what other stocks it's selecting. And to get a rough idea as to how on the mark the filters I'm using work.

Typically, I'll use the Nasdaq 100 to test with in the very beginning. Yes, I know...the Nasdaq 100 is a current snapshot of the Nasdaq 100. And it is the cream of the crop of stocks in the Nasdaq Exchange. So, if I'm looking for big gainers in the past...well the current Nasdaq 100 has them (and only them). In other words...the dice are loaded. But, regardless of these loaded dice I'm rolling with...using these stocks help initially in the test...let's me know just what the filters are picking up. And helps me find more examples to use in my development.

So, here are the results of the first test on the Nasdaq 100:

Win Ratio: 69.23%

Avg Profit: 180.34%
Max Consecutive Winners: 8

Avg Loss: -30.68%
Max Consecutive Losers: 2
Max Drawdown: -8.12%

Profit Factor: 12.54

Actually, not bad considering it's a first run. The profit factor of 12.54 is really nice considering I typically receive profit factors on first runs in the 5 to 8 range...if the idea has merit. Maybe we're on to something? :)

Here's some example trades from the backtest:







As you can see...some potential...but for the most part we're catching the stock a little too early in the process. I'm also worried that we might be filtering down too much. So, for the next test we might open the filters, especially the average price - the max closing low piece. Maybe less than 1 ATR is a bit too tight. We'll see. Until then...

Later Trades,

MT

Developing Melba Toast

I usually keep system ideas and designs to myself. I let my readers in on the mechanics of system trading such as money management, position sizing, etc. But, the actual generation and creation of a system has always been personal. And to be honest...never wanted to give away an edge.

I guess, times are a changing. I've decided to develop and test a system idea in real-time here on the blog. My point isn't to build a system for you, the reader. The point is to share my process...how I capture an idea logically. And more importantly how to continually develop and test until a) the idea's acceptance into the trading library or b) the idea's admittance into Heavenly Hills System Cemetery.

So, what's the idea?

Ever sell a stock out of boredom? When you bought the stock...it looked great. But, after months of underperformance...no better yet...after months of the stock doing nada...you sell. The good news is you didn't really lose money on the investment. But, didn't make any either.

A few weeks or months after closing out your position...the stock breaks to a higher level. Not by a whole lot...still higher than you've ever seen while holding the melba toast. Since the price isn't that much higher than your selling price...you ignore it.

Weeks...months...maybe years go by. Then, like the curiosities of an old flame, the mind wonders...what ever happened to that stock I held back in the day? Pulling up the quote in Yahoo Finance hits you like a Mac truck. That melba toast gained more than 10 times the price you sold it for. Oh, if only I had held it. If only I could stand a little fiber in my diet.

How many of these stocks have you encountered in your trading life? I've experienced plenty. Here are some examples.









About 90% of my equity is allocated to my systems. Around 10% is left as fun money. I can buy stocks for any reason and hold for as long or short as I like with this fun money. The examples above are trades made with this fun money. As you can tell...the trades were horrible. But, this fun money does two very important things for me.

1. Allows me to release the self-destructive side of my trading where I can participate a bit with the market masses without destroying my bottom-line.



2. By participating in the euphoric buying and panic selling sprees I feel all the things the masses feel. I know what it's like to put 100% of my fun money into one position and get hit like The Equities Research Center's FCL trade. To experience those feelings enable me to observe the patterns and more importantly generate system trading ideas.

And with that we get to the main point. How do we logically capture the stocks that go from nothing to something? The Melba Toasts of the world?

My initial thoughts are to identify areas in the time series where buyers are not rewarded. Basically, no new highs are made within a certain time period...let's say one year or 50 weeks.

What about the downside? I think it's okay for the market to make new lows...but not too much on the downside. So, maybe we can check the max closing low for the past year and compare against the average. How many ATR's is the lowest closing price from the 50 week average? Less than 1 ATR sounds about right.

What else? Hmmm...trend. Yes, we need to check the trend of the stock. We basically need a stock that is not trending upwards. So, trending downwards to a degree...or better yet...no trend at all will provide the maximum frustration for holders of the stock while still keeping them in it.

Let's also add a minimum volume filter of at least a 50 week average daily volume greater than 20,000 shares.

So, what do we have?

• No new highs within the past 50 weeks;


• (50 week average close - 50 week lowest closing price) less than 50 week Average True Range (ATR);


• No uptrend in place;


• At least 20,000 shares traded daily for the past 50 weeks.


• We'll slap a 2 * ATR disaster stop and a 3 * ATR trailing stop from the closing price.

Results? Here's what we've captured on the LGF chart with these rules in place:




Looks good, huh? Well, believe it or not...we've got one heck of a long way to go. LGF is just one stock. Now, the real work begins. And I'll have to leave that for another night. Until then...

Later Trades,

MT

Quote of the Week - Winners

"Winners compare their achievements with their goals, while losers compare their achievements with those of other people." -- Nido Qubein

Gotta admit, I'm guilty of this losing trait...comparing against others. And it's one I'm determined to work on for 2006. But, first...gotta make some goals. :)

Later Trades,

MT

Quote of the Week

"All progress is precarious, and the solution of one problem brings us face to face with another problem." -- Martin Luther King Jr.

Great quote isn't it? And very true.

Sidenote:
Looking for more information on money management/position sizing? There's a nice little thread from EliteTrader discussing the topic. Read here.

Finally, investors tend to believe sentiment is too optimistic if a top magazine's cover is bullish. Do we give equal attention to bearish magazine covers and their potential implications? It looks like we have a new test case: the current cover of The Economist. And it seems most people are missing the contrarian indications.

Have a great week everyone!

MT

Ed Seykota Student Interviews

Insightful post from Michael Covel on Ed Seykota's Class of 2002 here. Interesting bytes:

"To me trend following is more than an investment philosophy it is a way of life. Once I became familiar with how to stick with what is working and get rid of what is not, my personal life as well as my trading saw vast improvements. Unhealthy relationships and losing trades are cut and all I am left with are winning trades and rewarding, supportive relationships." -- Jason Dekker

"Trend following at its core is "simple", but the key lies in the consistent execution of a positive expectation system over time." -- Michael Covel.

Yes, simple is the trend following system. The complex is the consistent execution. It is amazingly hard to stick to a trend-following system year after year. Harder than this old country boy would like to admit.

Have a great weekend!

MT

Update on Innovating Exits...Graphs

I've updated the Innovating Exits post with graphs from one of the system's past trades. I've also described a bit of the system in the comments section of the post. Check it out.

I shared some quick research on Trader Mike's beloved T2108 indicator in a recent post of Mike's. You can read my comments here. Trader Mike uses the T2108 as an overbought/oversold indicator on a daily timeframe. I find it useful as a trend strength indicator on a weekly timeframe. Just goes to show...more than one way to skin a cat.

You know, there are just times when you need to jump on bike and get out of dodge. What better bike than this new one from Triumph...The Scrambler.


Source: Forty Years on Two Wheels.

Later Trades,

MT

Innovating Exits

I haven't written much on system trading lately. Mostly, because I've been wandering out in the deep jungle of quantitative finance and to be honest...got lost. I got so engrossed in theory that I forgot just what I was after.

Luckily, I found an old creek that led me back to my entry point. A little weary but a little wiser and more appreciative of the systems I currently trade. What's really amazing is after 5+ years of developing systems and trading them...the very first one is the most successful. And the second one is the second most successful. And the third is the third...and so on...and so on.

This reminds me of a programming conundrum that I run across all the time. When tackling a problem of how to program a certain piece of logic...my very first solution to the problem is always the best. And I don't know why. Because the solution I come up with isn't an "Aha!" moment. It's basically a thought that you "could" do it this way...but I'm sure there's a better way. And notoriously, there isn't. It's always that first split-second solution that is the most adept at cutting straight to the heart of the problem and getting the job done. Crazy, ain't it? Especially, if you're a logical type of person who believes the more thought applied to a problem, the better the solution will be. Wanna know what's crazier?

There are programmers out there who do not have this type of split-second solution ability. Or...they do and don't honor it. Allowing themselves to stew on the problem too long. Thus, the corresponding logic and code is horrible. These "gifted" programmers have a name...The Innovators. And know what? Nobody wants to support or work on an Innovators code. Funny.

Anyways, back to the post. One of my original systems (2nd one) has always had impressive entry logic. But, I never focused on the exit piece just because the entry worked out so well. The exit to the system is a cut-and-paste job from my first system's exit logic. Your basic run-of-the-mill ATR trailing stop. Take a stock's current price and subtract it's ATR multiplier. For example:

XYZ stock closed at $30.00.
Average True Range (ATR) for 5 days: $4.00
ATR Multiplier: 3
ATR Trailing Stop := Close - (ATR * Multiplier) := $30.00 - ($4.00 * 3) := $18.00.

This ATR Trailing Stop would scale up...never down...as the price of the stock closed higher and higher or as the stock grows less volatile. And then, if the price were to close below the ATR trail...you'd exit your position.

Get the picture? Now on to my system. The problem I've noticed after trading this system for a number of years is that investments (stocks) would exhibit very small ATR's for the majority of time but every so often experience a huge expansion of range for just one day taking the price many points higher. As a result, I'd get kicked out early in the long-term move because volatility would sink back down, price would sink back down, while those price spikes scaled me up on the trailing stop to a level that didn't fit with the overall move in the stock. Cause as I said before...we always scale our stops up...not down.



What to do, what to do? The easy solution was to change our ATR Trailing Stop formula to use the Average price instead of the Closing price to determine our trail. The new formula would look like this:

XYZ stock closed at $30.00.
The average closing price of past 20 days: $27.00
Average True Range (ATR) for 5 days: $4.00
ATR Multiplier: 3
ATR Trailing Stop := AverageClose - (ATR * Multiplier) := $27.00 - ($4.00 * 3) := $15.00.

As you can see, we decreased our trail 17% from the original trail. This might not be the right thing to do in most trading systems. Since most systems are trying to capture range expansion in some shape or form. But, if you're one of the few long-term traders out there who try to capture long-term moves...expansion is not your friend. It will shake you out prematurely. Changing the calculations in your systems to moving averages instead of just one or two price points...may help keep you with the trend longer.



Note: Please check out the comments for further detail on the type of system being used in the ATR Trail example.

Later Trades,

MT

Quote of the Week

"Only as you do know yourself can your brain serve you as a sharp and efficient tool. Know your own failings, passions, and prejudices so you can separate them from what you see." -- Bernard Baruch

The brain can be a wonderful tool or a horrific set of tinted glasses that bias everything you see. And these tinted glasses can be an extremely expensive accessory to wear in the market.

On to other things. My daughter and I are planning a Spring vegetable garden. Should be lots of fun. I figure there's no better way to teach her the following:

"Don't judge each day by the harvest you reap, but by the seeds you plant." -- Robert Louis Stevenson

And I hope the teacher learns as much as the student. :)

Later Trades,

MT

Quote of The Week

"In these times, when so much is written about the "money supply" and when some observers assert that an abundance of money will forestall a slump, it is interesting to note this comment by Senator Burton: "...paradoxical as it may seem, the starting point for crises and depressions may be found in abundance rather than in scarcity, whether of money or capital." -- Humphrey B. Neill in his book, The Art of Contrary Thinking, which was first printed in 1954.

True words of wisdom by the great Vermont Ruminator. In seeing all the wasted words spent on the yield curve conundrum this past week...I figured I'd waste a few more...

"The reason the contrarian needs to be aware of history, in this regard, is because changes in trend occur before the masses are consciously observant of the fact. Also, because when socio-political conditions seem to revolve and repeat, the average person (of brief memory) is unaware of the "cycle" and is likely to think that a "new" condition has developed." -- Humphrey B. Neil

So, what's that leave us with? Well, possibly we need to analyze the current trend in the markets. For a few years, the markets seems to have priced in a good sound economy. Do you believe the next year will see more of the same? Or will markets need to price in a little risk with that cup of joe?

Happy New Year everyone! I hope all have enjoyed their holidays. And gained focus on the tasks at hand for the new year. This year will be filled with many new events for yours truly. Found out last week that we're having a boy! Yeah! We are excited but our daughter is a little bummed. She was hoping for a little sister. But, once we told her that a little brother wouldn't play with her girl toys...she quickly warmed up to the idea of having a brother. Kids are funny that way. If only we as adults could be so adaptable.

P.S. This weekend I watched one of my favorite movies...Open Range with Robert Duvall, Kevin Costner, and Annette Bening. If you haven't seen it...you're missing out...Bucketmouth! :)

Later Trades,

MT

More Food for Thought

Thought these two posts were linkworthy...

Bill Cara shares his Rules for Successful Trading. Read here. My favorite rule? Rule #9: Take risks, not chances.

My wife and I were talking about the difference between Donald Trump and Warren Buffett last night. And it was just funny that I then find this post by the Daily Dose of Optimism on Trump's Rise to Wealth. Read here.

Just what were my wife and I discussing in regard to Trump and Buffett? Well, we were just making the case that Trump has a tougher row to hoe in staying rich because his wealth depends upon his lavish lifestyle. He has to project an image of a rich billionaire in order to keep his billionaire status. Buffett known for his value-conscious investments and lifestyle has a wider margin in his billionaire status. In other words, he can be cheap and still retain his status.

Gotta go...time to make cookies for Santa and Rudolph.

MT

Food for Thought

"Things should be made as simple as possible, but not any simpler." -- Albert Einstein

Diversification is Balderdash? Here.

This time it's different? First the New Economy and now the Inverted Yield Curve?. Here.

Baby Sitters, Protectionism, Starbucks, Export Bans, and the Bubble? Now that's my kind of economist. Read here.

Two great articles posted recently by Dan over at the The Art of Streetplay. Read Model Building Thoughts here. And Indexing the Answer here. He mentions a quote that "Stock picking is a very complicated process." I agree with that quote but with an addition..."Stock picking is a very complicated process because it is so simple."

Reminds me of programming projects I've worked on. Wanna know what the hardest projects were? Not the ones that seemed so complicated to understand at first that there was no way it could be done. Those ended up being fairly easy to design and implement. The simple little buggers are the ones that ended up causing the most problems. Time clock-in/clock-out systems for instance are very simple...yet very complex. I have spent more hours on time systems than I've ever spent on designing and implementing the merge of a sysplex into a 24-hour window. Y2K...very simple...yet very complex. Payroll...cut a person a check...how hard is that? Simple...yet complex.

Are simple things turned into complex things because of people? Or are simple things complex because the multitude of variables effect on the simplest of things? And people just happen to be one of those variables? Too deep for me.

I just know the more I study the market the less I end up knowing. A very humbling experience. So, I find myself over the years sticking more and more to the simple stuff which takes me into very complex directions. The vicious cycle of simple to complex to simple...never ends.

Happy Holidays!

MT

Quote of the Week

"Listen to what the market is saying about others; not what others are saying about the market." -- Richard Wyckoff

Nice quote. Don't listen to all the yick yack from others. Listen to the market. If the world is falling apart...is gold rallying? If we're going to have a rough 2006...how are the tech stocks doing? If gold and techs are both on the rise; what's Mr. Market trying to tell us? Hmmm...

While you're chewing on that...check out the two articles below.

The CEO of Raytheon, William Swanson, shares his management lessons...here. My favorite rules? Rule 30: Short them to the ground.

Bloomberg asks "What is Your Total Return?"...here. I have to admit...I asked myself one of the same questions mentioned in the article just a month or so ago. "Are you doing what makes you feel most alive? Does what you do add or subtract from your overall goals and happiness?" Careful about asking yourself this...life changes can occur.

Later Trades,

MT

Millionaire Next Door?

"Seeds are a lot like dollars. You can eat the seeds or sow them. But when you would see what seeds turned into...ten-foot-high corn...you don't want to waste them. Consume them or plant them. I always get a kick out of watching things grow." -- quote from Millionaire Next Door

Every so often I pull a book down from my library and skim through the pages just seeing what catches my eye. This morning I pulled down The Millionaire Next Door by Thomas J. Stanley and William D. Danko. This book uncovers some interesting statistics regarding millionaires in America. Here's just a few...

Self-employed people make up less than 20% of the workers in America but account for two-thirds of the millionaires.

About half of the millionaire's wives do not work outside the home. The number-one occupation for those wives who do work is teacher.

About 80% of millionaires are first-generation affluent.

Have more than 6 1/2 times the level of wealth of their nonmillionaire neighbors, but, these nonmillionaire neighbors outnumber us better than 3 to 1.

How to determine if you're wealthy? Multiply your age times your gross annual income and divide that figure by 10. This figure is what your net worth should be. For example, if your gross annual income is $70,000 and age is 34...then you're net worth should be $238,000. If your well under that figure...you're an UAW (under accumulator of wealth). If well over that figure...a PAW (prodigious accumulator of wealth).

The reason why I enjoyed this book so much when I bought it 3 or 4 years ago is because of its contrarian tale. Millionaires aren't the figures you have conjured up in your mind that live lavishly, spend furiously, and never worry about money. They're the people you overlook in a crowded room. The tightwads...driving used non-descript cars, working in dull industries, and loving every minute of it.

In fact, one of the few I do know is a welder in the backwoods of East Texas. Had him weld a car part for me a few times. Owned a pet raccoon, several dogs, and cats. Lives in an 80 year-old home with no central air/heat. Wife is a stay-at-home mom. He's around 40 years of age. How do you imagine a welder in a very small town struck it rich? He has sucked every last drop of opportunity from his land and welding business. Created a parking lot for overnight truckers where he receives money for parking as well as working on their rigs. Sells ad space on his high-traffic (for East Texas) road signs. The list goes on. And let's face it...he lives extremely frugal. The words tightwad have been mentioned several times when his name is brought up.

Another millionaire I know started out as a commercial fisherman on the lake. Ran trot-lines for catfish. Did fairly well in a barely break-even business. Then began an auto-repair business. Something thousands of mechanics have done. But, this one through extremely frugal living has turned it into one heck of a profitable business. And unbeknownst to many, has turned the land behind his shop into a very lucrative Pecan farm. Again, sucking the blood out of every last drop in his assets and being frugal with the returns have turned this local genius into a millionaire.

I'll leave you with one of my favorite stories of all time in regard to millionaires. It's one I have told over and over to many of my friends and coworkers. And best of all...it's from the Millionaire Next Door Book...

The first time we interviewed a group of people worth at least $10 million (decamillionaires), the session turned out differently than we had planned. To make sure our decamillionaire respondents felt comfortable during the interview, we rented a posh penthouse on Manhattan's fashionable East Side. We also hired two gourmet food designers. They put together a menu of four pates and three kinds of caviar. To accompany this, the designers suggested a case of high-quality 1970 Bordeaux plus a case of a "wonderful" 1973 cabernet sauvignon.

Armed with what we thought would be the ideal menu, we enthusiastically awaited the arrival of our decamillionaire respondents. The first to arrive was someone we nick-named Mr. Bud. Sixty-nine and a first-generation millionaire, Mr. Bud owned several valuable pieces of commercial real estate in New York metropolitan area. He also owned two businesses. You would never have figured out from his appearance that he was worth well over $10 million. His dress was what you might call dull-normal...a well-worn suit and overcoat.

Nevertheless, we wanted to make Mr. Bud feel that we fully understood the food and drink expectations of America's decamillionaires. So after we introduced ourselves, one of us asked, "Mr. Bud, may I pour you a glass of 1970 Bordeaux?"

Mr. Bud looked at us with a puzzled expression on his face and then said: "I drink scotch and two kinds of beer -- free and BUDWEISER!"

We hid our shock as the true meaning of our decamillionaire's message dawned upon us. During the subsequent two-hour interview, the nine decamillionaire respondents shifted constantly in their chairs. Occasionally they glanced at the buffet. But not one touched the pate or drank our vintage wines. We knew they were hungry, but all they ate were gourmet crackers.

When we interview millionaires these days, we offer a spread that is more congruent with their way of life. We provide them with coffee, soft drinks, beer, scotch, and club sandwiches. Of course, we also pay them between $100 and $250 apiece.

What are the three words that profile the affluent? FRUGAL FRUGAL FRUGAL.

Check out the book and more importantly, check out yourself and chosen lifestyle. Are you frugal enough?

Later Trades,

MT

[Edit: Corrected the calculation of "how wealthy you are." I miscalculated ($70,000.00 * 34) / 10. Does not = $280,000.00 but $238,000.00. Sorry for the mistake. ]

S&P 500 Index, Consistency, and Hot Stove Lids?

TraderMike posted a link to an article by Jon Markman titled, "The S&P 500 is a mutual fund - and a bad one." Before I begin my rant...first read the article. Really read it. Such things as:

"One myth that appears to be imploding along with the market is the notion that investors should “passively” buy the market via the S&P 500 Index ($INX) rather than buying individual stocks."

"This is not just a question of one company picking better stocks than the other. It’s a question of a flawed design that rewards sector momentum over common sense. Unlike most index publishers, such as the Nasdaq and Dow Jones, Standard & Poor’s adds and subtracts stocks from its three broad indexes -- the large-cap 500, the Midcap 400 ($MID.X) and the Smallcap 600 ($SML.X) frequently in accordance with a largely subjective list of criteria that includes market capitalization, liquidity and their representation of industrial sectors."

"It’s the latter criteria that got S&P into trouble in 2000 as it tried to keep pace with the explosive 1999 performance of the tech-heavy Nasdaq 100 ($NDX.X). Every month a number-cruncher at S&P adds up the total capitalization of all 9,000 or so stocks traded on U.S. exchanges, and determines the percentage representation of each broad industrial sector, such as technology, health care and capital goods. After technology stocks roared into favor in the late 1990s, S&P found that the market had given an 18% weighting to tech stocks while its index only had a 14% weighting. So the committee considered itself obligated to raise its weighting in tech stocks in short order."

"In 2002, S&P has continued its tradition of adding fast-rising stocks in the most popular industrial sectors to the S&P 500. In time, we will determine whether they were reflecting economic changes or simply the market momentum of regional banks, real-estate investment trusts, insurance and home improvement products. Top adds so far, in order of inclusion, are Plum Creek Timber (PCL), Ace Limited (ACE), Rational Software (RATL), Marshall and Ilsley (MI), First Tennessee National (FTN), American Standard (ASD), BJ Services (BJS), Apollo Group (APOL) and Simon Property Group (SPG)"

Markman posted this article in June 2002.Yes, 2002. Just 4 months before the bottom of the 2000 decline. Now, take a look at those stocks Markman mentioned being added to the index back in 2002.

Every single one of them are up and up pretty good I might add since their inclusion. Oh, sorry...Rational Software was bought by IBM and First Tennessee National by First Horizon...so they didn't go up as much as the others. But, a 100% hit rate isn't too shabby for a bad mutual fund as Markman calls it.

What does this say about Markman's theory on the S&P 500? His all-knowing implications of we'll just see how badly you fail by adding fast-rising stocks in the most popular industrial sectors? Hmmm...

I think Markman suffers from what most investors including myself suffer from...lack of consistency. That's why you have to admire a guy like Roger Nusbaum over at Random Roger's Big Picture. I've read his blog over a year now and he has stuck to the same investing approach month in and month out. Market does great or market does bad...he's the same. He might suffer from a lack of exciting material to write about at times...but better for that to suffer than his or his client's returns. There's a lot to learn from that approach.

Consistency. How do you become consistent like Roger? How do you get to the point of knowing your investment methodology will work long-term? And then trusting it despite what Mr. Market throws at you?

Maybe this quote will help...

"We should be careful to get out of an experience only the wisdom that is in it — and stop there; lest we be like the cat that sits down on a hot stove lid. She will never sit on a hot stove lid again — and that is well; but also she will never sit down on a cold one anymore." -- Mark Twain

Are we too focused on the hot lids of 1929-1932, 1969-1970, 2000-2002? Does that explain Markman's rant and his ever changing cycles shared with Neiderhoffer?

Have we forsaken consistency for market strategies that avoid those hot stove lids? Buy gold...market looks weak. Inflation rising. Warning, warning, warning Will Robinson. When the lid proves cold...what are we left with?

Or is our focus only on the cold stove lids? Buy the bull...everything looks great. The flowers are blooming and there's not a cloud in the sky. We're in stage 4 of the business cycle and firing on all pistons. Charge! When you burn your tail on the eventual hot lid with too much money on the line...what are you left with?

Maybe we narrow our focus and reduce the duration of our holdings hoping to side-step all lids regardless of hot or cold? Never sitting long enough in one spot even if that means we never sit down at all? Churn.

Perhaps Twain had it right...understand the market is filled with hot and cold lids (stocks). And that's it. Nothing more and nothing less. Focus on the goal at hand...finding a place to sit your money. If the plate is hot...get up and move to the next spot. Never sit long enough on a hot lid (cut your losses) nor put enough weight down on all lids (position sizing) to get burnt badly. Find a place to sit and do what cats do best...sleep (compound).

Goodnight,

MT

Quote of the Week

All who succeed in life get off to a bad start, and pass through many heart-breaking struggles before they "arrive." The turning point in the lives of those who succeed, usually comes at the moment of some crisis, through which they are introduced to their "other selves." -- Napoleon Hill

Later Trades,

MT

Crop Stock Management

Found a great article over at the University of Minnesota's Extension Service that relates to the tree business I referred to in my previous post. There's a section in the article that discusses Crop Tree Management. Here's part of the text:

Crop tree management is very similar to thinning carrots in a garden. If you leave too many carrot seedlings, you end up with many scrawny carrots and few nice ones at the end of the season. It works the same way with trees.

Crop tree management is a technique developed to generate high-value sawlogs. This makes your woodlot more valuable and increases the financial return from your trees. This technique usually does not apply very well to pulpwood production. In crop tree management, as few as five to more than ten trees per acre can be selected as candidate “crop trees.” Crop trees are the best trees in the woodlot. These are the trees that will be kept in the forest to grow in size and value. This does NOT mean that a landowner cuts all of the other trees, but instead means that the crop trees get special treatment that is not given to the others. A crop tree is usually:

• A long-lived and desirable species
• Straight and tall
• Free of obvious disease
• Free of defects, especially large wounds
• In the uppermost canopy layer (in a dominant or co-dominant position)

When selecting crop trees, it is important to note that the tree does not need to be large, just in the upper canopy. Some of the biggest gains in value can come from trees that are 6–10 inches now, but will be 12–14 inches or more at the final sale.

After the candidate trees have been selected, the trees that are directly competing with them are removed. This usually means trying to release the crowns (the top) of the crop trees from competition on three or four sides. After the treatment, the crowns of the crop trees should be separated from adjacent trees by about 15 feet. This will allow the tree to grow with much less competition and to put on much greater volumes of high-value new wood. These few, really good quality trees usually hold most of the value in the stand when cut for sawtimber.

Now, what does that have to do with investing? Hmmm.... Let me convert the above text into what my mind saw:

Crop stock management is very similar to thinning carrots in a garden. If you leave too many carrot seedlings, you end up with many scrawny carrots and few nice ones at the end of the season. It works the same way with stocks.

Crop stock management is a technique developed to generate super stocks. This makes your investment portfolio more valuable and increases the financial return from your stocks. This technique usually does not apply very well to daytrading strategies. In crop stock management, as few as five to more than ten stocks per portfolio can be selected as candidate “crop stocks.” Crop stocks are the best stocks in the portfolio. These are the stocks that will be kept in the portfolio to grow in size and value. This does NOT mean that an investor sells all of the other stocks, but instead means that the crop stocks get special treatment that is not given to the others. A crop stock is usually:

• A long-lived and desirable stock
• Uptrend that is tight and strong
• Free of obvious disease - unprofitable, high debt, etc.
• Free of defects, especially large wounds - facing bankruptcy, lawsuits, etc.
• In the uppermost canopy layer (in a dominant or co-dominant position) - new highs dominate the chart

When selecting crop stocks, it is important to note that the stock does not need to be highly liquid, just in the upper canopy. Some of the biggest gains in value can come from stocks that are thinly followed now, but will be heavily followed by the final sale.

By applying Crop Stock Management to our investment portfolios...perhaps we can grow crop stocks into super stocks .

Later Trades,

MT

Improvements ain't all that!

How's that for a title? Well, that's something I've always ranted and raved on for years and years. My contention has always been...this world we live in is zero-sum. You can't improve anything without taking something away. So, improvement is dependent upon which person you talk to.

Corporate farms have enabled us to consume our milk, eggs, bacon, hamburgers, steaks, etc. all at a price that is easy to stomach since we never have to step foot onto a farm or ranch. Especially considering John F. Kennedy's quote, "The farmer is the only business man who buys at retail, sells at wholesale and pays the freight both ways."

But, this improvement on farming came at a cost...to the cottage farmer. Gene Logsdon brilliantly highlights these costs in his classic book, The Contrary Farmer.

So, what's my point? Not much...just trying to find a nice little segue into the following article I found over on DeepWealth. Read here. It's an extract from Charlie Munger's speech on what technology improvements can do to a company...person...a commodity. Favorite part?

And he knew that the huge productivity increases that would come from a better machine introduced into the production of a commodity product would all go to the benefit of the buyers of the textiles. Nothing was going to stick to our ribs as owners.

That's such an obvious concept - that there are all kinds of wonderful new inventions that give you nothing as owners except the opportunity to spend a lot more money in a business that's still going to be lousy.The money still won't come to you. All of the advantages from great improvements are going to flow through to the customers.

The great part about that statement is just how true it is. I have witnessed this effect time and time again in regard to technological improvements made in business. The crazy part...besides myself?

Most people never hit the conclusion that Buffett came to so quickly. Is it really worth doing if I have to invest all this capital only to keep up? Now, I'm not saying we should halt all progress...Close the mill...so to speak. Just trying to make the point that improving our lives...our businesses...the world, comes at a cost.

High-speed Internet? How's that family you never see?

Great investing tools...clean reliable stock data feeds...real-time scan streamers? How's the hunt for those market inefficiencies coming? And at what cost? Only to keep up?

Nice car? Yeah? How's that 45 minute commute?

Nice house? How's that mortgage?

My dad used to mention how it took him 25 to 30 hits to find oil back in the day...now it takes only 2 or 3. But, the cost is the same if not higher.

So, what to do...what to do? To me, I've always thought you should take into account all costs of the improvement (both real and lost) and figure out if there's a way to break off from the pack and create value in a different area and with that capital from the so-called "improvement".

How does this relate to trading? Hmmm...Let's see...if everyone is focusing on short-term returns and investing more and more capital into trading technologies to generate those returns...then how are you ever going to get ahead? Cause let's admit it...the margins are pretty crummy anyway. Technology is only going to reduce those margins further. So, maybe we need to do as Gene Logsdon suggests and break away from the pack....if everyone is going short-term...go long-term baby! Maybe Buffett said it best...

"Someone's sitting in the shade today because someone planted a tree a long time ago."

Just maybe we need to look into the tree business. That is after all one of the top search hits on this site. :)

Later Trades,

MT

Quote of the Week

This week's quote comes from a great find by The Buffett Blog. An interview with Charlie Munger from Kiplinger.

The quote?

"If the price of automobiles were going up 40% a year, you'd have a boom in auto stocks. But if you stop to think about it, of the companies that you could have bought in, say, 1911, to hold for a long time, one of the very best stocks would have been Rockefeller's Standard Oil Trust. It became almost all of today's integrated oil companies." -- Charlie Munger

Wow! Munger has given us all something to chew on for awhile. What will fuel the next 100 years?

Later Trades,

MT

Quote of the Week

"When there are no fish in one spot, cast your net in another." -- Chinese Proverb

How many of you get stuck in your trading? Can't seem to make progress? Well, sometimes the fish just aren't there to catch. You can work as hard as you want and still catch nada. The key is to cast that net until you find fish.

What happens when no more fish are caught? You must move on...because the fish already have.

Later Trades,

MT

Taylor Turkey System

Once again it's that time of year...time with family, counting of blessings, stuffing your face...and most of all...the Taylor Turkey System!!! For those unfamiliar with the system you can read the original post here and the follow-up here.

Under the system, you purchase the index on Wednesday (day before Thanksgiving) and sell the Monday after Thanksgiving. How will it perform this year? Ah, should be interesting. Will I invest my hard-earned money? No, probably not. While it's a fun little system showcasing the holiday effect...just too few data points for me. But, with a quick and dirty test on the current Nasdaq 100 stocks...you earn a profit factor of 3.15. Of course, that's not counting commissions and slippage. Still, not too shabby for turkey lurkey day.

Well, gotta get...some more system work to do. Just what kind of stuff am I working on? Hmmm...let's see...it involves a bit of Bill Cara's Value Line Research, Victor Neiderhoffer's Triumph of the Optimist, Michael Covel's Trend Following post, and Ben Bernanke's MO.

I hope all is great with you and yours. Everyone have a wonderful Thanksgiving.

P.S. TraderMike needs to start working on those New Year's Resolutions for 2006! Time is a tickin! Ha ha!

Later Trades,

MT

Quote of the Week - Decision

Analysis of over twenty-five thousand men and women who have experienced failure disclosed the fact that lack of decision was near the head of the list of the thirty-one major causes of failure.

Procrastination, the opposite of decision, is a common enemy which practically every man must conquer.

Analysis of several hundred people who had accumulated fortunes well beyond the million-dollar mark disclosed the fact that every one of them had the habit of reaching decisions promptly, and of changing these decisions slowly, if and when they were changed. People who fail to accumulate money, without exception, have the habit of reaching decisions very slowly, if at all, and of changing these decisions quickly and often.

I believe these quotes are from Think and Grow Rich by Napoleon Hill. But, found them in the MasterMind Forums here.

These quotes are the type that should be read more than once. Allowed to soak in your brain. Stew over. Or as they say where I'm from, "Chew on for awhile."

And one last one from Hill for dessert:

"You must get involved to have an impact. No one is impressed with the won-lost record of the referee."

Later Trades,

MT

Quote of the Week

"Try a thing you haven't done three times.
Once, to get over the fear of doing it.
Twice, to learn how to do it.
And the third time, to figure out whether you like it or not."
-- Robert Evans (creator of Godfather)

Great words of wisdom. Especially for ADD'ers like myself. Easy to get frustrated with something and cross it off your list forever without ever taking the time to find out whether you truly like it or not.

The quote was from Robert Evans. Ever heard of him? I hadn't before I found this quote a few years back. Evans has lived quite an interesting life. Read this interview for some particulars, and don't miss out on how Evans discovers "The Smile"....aka Jack Nicholson.

New Blog Find

Found a very interesting blogger, Arpit Ranka via The Learning Blog's links.

Check out his post on The Reminiscences of an Infant Investor. I quite like his behavioral bent to investing/trading.

Favorite lesson from his post? "Lesson 2: You are not as smart as you think you are."

Ain't it the truth.

The site also has several great quotes sprinkled throughout. Such as this one from Pascal: "Heart has its reasons, that reasons don't understand." Nice!

MT

Serenity Now

oil_rig_net, originally uploaded by TaylorTree.

Well, this might not give the old oil rig workers much serenity now...more like the bad memories, nightly sweats from before. :)

Seriously, this is what you had to climb in on if you wanted to do offshore work in the gulf.

My dad is the 2nd on the right. Picture taken in 1954.

MT

Nassim Taleb Interview

Weird that I checked Taleb's site the other night and found the Notebook. And then noticed I'm ranking #1 on blogsearch.google.com and #2 on Technorati.com for "Nassim Taleb" searches. From Technorati I found a recent interview with Taleb from SmartMoney.com here. Great interview by the way. Here are some of my favorite parts:

Psychologists ran experiments to see how people absorb information. In one experiment they found people who work with racehorses, and asked them to name up to 50 pieces of information they would need [to determine if it was going to be a winner]. They ranked them by order of importance. They took the 10 most important ones out of 50 and looked at the prediction of accuracy to determine if a horse will win a race. Then they took the 20 most important pieces, then the 30. In the end, you had no gain in predictive power beyond the first 10 pieces of information, but a huge gain of overconfidence...

It's the market that creates the indicator, not the indicator that creates the market.

To become Bill Gates you need more luck than skill. But to become a prosperous person, you need more skill than luck.

I believe Warren Buffett has skills, but probably two-thirds of it comes from an environment that helped him.

I am unable to predict markets, but I know it.

The favorite quote being the Bill Gates more luck than skill. I've referenced that type of thinking back in this post on Relativity by Dr. Mike Ott here. I strongly believe that environment makes up at least 2/3 of a person's success. The other 1/3? Ah, that's your edge.

Got Edge?

MT

Random Markets?

Check out the Coin Toss Simulation - Visualizing Randomness from this link. Enter an amount in the Number of coin tosses box and press the "Simulate" button. Go ahead...enter 500000. Hmmm....

MT

Taleb's Notebook

Occasionaly, I peruse Nassim Taleb's site just to get a reality check on my system development activities. Tonight, I noticed Taleb has setup a Notebook that he notes is not quite a blog (funny). Read it here.

Not much happening on the homefront. Busily evaluating a trading idea....while the list of new ones rapidly pile on my desk. Speaking of desk notes...I have to really thank one of the commentors on this blog for recommending EverNote. I was very reluctant at first especially since it involved organizing my thoughts from the scattered scraps of paper and journals to a forum that's neat, tidy, and structured. But, I've really grown to like this little product. I'm slowly but surely beginning to keep everything stored in EverNote and the pile of notes are becoming electronic in form. Kinda cool. At least my wife thinks so. :)

This weekend? Somehow got wrangled into installing ceramic tile in my dad's kitchen. Hows' that for a howdy-do? But, it should be fun and filled with adventure. I'm just afraid the rest of the family will see the results and want more of the same. They'll just have to wait because dad has bigger plans for this computer geek...hardwood flooring!

One last thing...check out the movie Dreamer with Kurt Russell, Dakota Fanning, and Kris Kristofferson. I was really surprised...my wife and I saw it on our date night and I thought it had chick flick written all over it. That might be...still a good heart-warming movie that showcases the struggle of safety and stability against risk and opportunity.

Enjoy your weekend!

MT

Quote of the Week - Einstein

"It's not that I am so smart, it's just that I stay with problems longer." -- Albert Einstein

Boy, Albert, I sure hope you're right. Cause I've been trying to figure out this market for a heck of a long time!

Question is...how long should you stay with the problem versus cutting your losses and moving on to something else? How many other Einstein's have stayed with the problem til' their dying day...never solving the problem?

To test this theory out...

Try picking stocks and setting a profit target of 50% and don't sell until they hit it. Only two possible outcomes to this test: Stock will hit the profit target Or it won't. Time is removed from the equation except for the length of your lifespan. If the profit target is hit...you'll have found an Einstein.

Same Test as above but exit the stock if 50% target is not reached within a year. Same possible outcomes as the prior test but Time is added to the equation.

Are you better for your Sticktoitiveness or for Cutting Losses Short?

P.S. Would be interesting to see how many stocks bought the day of their IPO acheive their profit target and go on to become Einstein's? Would we consider 50% gain worthy of Einstein status? 100%? 300%?

Later Trades,

MT

Quote of the Week

Since I couldn't find a picture for this week's Serenity Now...I've decided to post a Quote of the Week. I actually thought of today's Quote of the Week from a discussion I've had with Jon Tait (FickleTrader) in regard to burning the midnight oil in an effort to build our systems.

"The Heights by Great Men Reached and Kept were not Attained by Sudden Flight, but They, while their Companions Slept, were Toiling Upward in the Night." -- Henry Wadsworth Longfellow

Maybe I'll try to post a Quote of the Week every Monday.

Have a good weekend everybody! My plans? Well, I plan to put my daughter to work. She received a rocking chair from her Papa on her birthday. And she would like it finished the color purple. So, her and I will sand and prime the chair this weekend. Should be fun.

MT

System Analyzer and Y2K

I've been working on a heck of a project. I'm trying to create my own System Edge Analyzer using a bit of Python and mostly R. I still have much work ahead but thought I'd give you a preview as to the initial output of the project. And no, the FathersDay Edge is not about trading on Father's Day. I named it after the day I stumbled upon the edge which happened to be Father's Day.

Also, check out Jon Tait's discussion on Profit Factor and his sneak peak of his backtesting project.

System Analyzer - FathersDay Edge

Sector Return Trades WinPct AvgPL AvgWin AvgLoss PFactor Sharpe 1 Overall 20375.77 9510 78 2.14 5.3 -8.91 2.11 0.3 11 pyAerospaceDefense 50.2 15 73 2.6 4.56 -2.81 4.39 65 12 pyAutomotive 267.02 71 63 0.39 5.93 -9.21 1.1 4.33 13 pyBanking 298.85 74 86 3.08 4.67 -7.11 4.03 34.22 14 pyChemicals 235.89 48 85 3.23 5.75 -11.58 2.81 46.14 15 pyComputerHardware 1825.94 432 79 2.5 5.35 -8.18 2.46 11.9 16 pyComputerSoftware 5378.91 1333 79 2.13 5.14 -8.86 2.18 6.09 17 pyConglomerates 0 0 18 pyConsumerDurables 789.88 196 77 1.98 5.27 -8.73 2.02 14.14 19 pyConsumerNonDurables 411.83 112 75 1.62 4.9 -8.23 1.79 14.73 110 pyDiversifiedServices 2194.29 522 77 2.19 5.44 -8.85 2.06 9.52 111 pyDrugs 6024.43 1418 79 2.03 5.38 -10.54 1.92 5.64 112 pyElectronics 4420.77 1123 78 2 5.06 -8.7 2.06 6.25 113 pyEnergy 1109.56 245 80 3 5.69 -7.5 3.03 18.75 114 pyFinancialServices 350.55 97 74 1.99 4.87 -6.29 2.2 19.9 115 pyFoodBeverage 194.33 47 79 2.41 5.25 -8.1 2.44 34.43 116 pyHealthServices 3606.47 863 78 2.23 5.37 -8.82 2.16 7.69 117 pyInsurance 360.69 104 65 0.79 5.3 -7.73 1.27 7.9 118 pyInternet 2702.58 622 79 2.22 5.48 -10.25 2.01 8.88 119 pyLeisure 513.61 125 75 1.81 5.46 -9.28 1.77 16.45 120 pyManufacturing 1344.04 307 80 2.6 5.49 -8.78 2.5 14.44 121 pyMaterialsConstruction 452.44 92 86 3.99 5.73 -6.54 5.38 39.9 122 pyMedia 694.87 174 72 1.53 5.56 -8.74 1.64 11.77 123 pyMetalsMining 396.86 94 78 2.75 5.44 -6.59 2.93 27.5 124 pyRealEstate 82.87 28 64 0.27 4.6 -7.53 1.09 5.4 125 pyRetail 566.23 130 78 2.4 5.61 -8.75 2.27 20 126 pySpecialtyRetail 632.62 145 74 2.56 5.86 -7.07 2.36 21.33 127 pyTelecommunications 3063.99 775 76 1.81 5.19 -8.99 1.83 6.7 128 pyTobacco 64.03 13 100 4.93 4.93 123.25 129 pyTransportation 204.06 55 71 1.63 5.23 -7.14 1.79 20.38 130 pyUtilities 138.81 26 92 5.09 5.78 -3.29 20.2 101.8 131 pyWholesale 845 224 76 1.96 4.94 -7.66 2.04 13.07

Funny, how it has taken many hours/weeks and brain-fried late nights in order to input, process, output into the simple little HTML table above. Reminds me of a story about the Y2K problem.

I was working around the clock for hours, weeks, and months on end in order to get our administrative systems ready for Y2K. For those few who don't remember...the Y2K issue centered around the fact that legacy systems used the 2 digit years instead of the 4 digits. And year calculations and comparisons drive a multitude of systems. So, if you compare the year 05 against 99...you get issues. Capisci?

Anyways, while I was burning the midnight oil getting everything in order...either converting everything to 4 digit years or windowing the problem...I got a call from a friend of mine.

Friend: "Hey, have you heard about this Y2K crap? Everybody is just making this Y2K stuff up, I tell ya. You watch...when January 1, 2000 gets here...nothing will happen."

Me: "You're right, nothing will happen because programmers like me have been working our butts off trying to make sure nothing will happen."

Friend: "Huh?"

Me: "Listen, it works like the George Soros Reflexivity theory. If all the programmers know there's a Y2K problem then the Y2K problem grows less of a problem as more of the problem is understood and worked on by those programmers. So, you are correct, when January 1, 2000 gets here...nothing will happen."

Friend: "Huh? Are you telling me Y2K is or isn't a problem."

Me: "Ah, Forget it. I gotta get back to work."

Friend: "Whatcha working on?"

Me: "The Y2K problem...[hangup]"

Six months later my friend calls me up on January 1, 2000 after I had stayed up all night to ensure our batch systems ran correctly and was still in the process of verifying their results.

Friend: "Hey, Happy New Year! I don't mean to rub it in...but I knew it, I knew it, I knew it! That Y2K was just a bunch of mumbo jumbo! Like I told you before...here it is Jan 1, 2000 and nothing...NADA...happened!"

Me: "Happy New Year yourself. And yes, there was a Y2K problem and we fixed it so nothing happened like I told you before!"

Friend: "Huh? Now, Mike, how can it be a problem if nothing happened!"

Me: "Ah, forget it...go watch your football games...I gotta get back to work"

Friend: "Work? Work? On New Year's Day? What the heck? What they got you working on now?"

Me: "Y2K...[hangup]"

Later Trades,

MT