Contents
Introduction
Foreword by Cole Wilcox
Foreword by Cullen O. Roche
Chapter One: Stick to Your Knitting
Night Class
Teaching Friends
The First 17 Trades—Losers—or Don’t Ask Around
Friends and Family Plan
Markets Are Not Efficient
Expanding Your Horizons
Knowing What You Don’t Know
White Noise
The Big Money
Chapter Two: Someone’s Gotta Lose for You to Win
The Chart Doctor Finds A Mentor
The Source of Profits
Keep It Simple and Start Small
“Put your Affection on Portfolio Selection!”
Stick Around for the Dance
Chapter Three: No Guts, No Glory
Numbers Obsession
No Prediction
Sticking With It
Risk and Volatility
Chapter Four: In a Land Far, Far Away from Wall Street
Teach Yourself to Be Great
Focus on the Show!
Playing Games
Risk!
Build on a Foundation of Confidence in Your System and in Yourself
Chapter Five: Think Like a Poker Player and Play the Odds
Irrelevant Information
Hite Gems
Perfect Knowledge
Even Mentors Have Mentors
Dating Game
How Much Can You Lose?
The Backstory
Chapter Six: Stand Up, Dust Yourself Off, and Keep Going
It All Starts with the Tedious Grind
Don’t Get Caught Up in Labels
Trader’s Kryptonite
Conventional Wisdom
Not the Art, the Science of Trading
Stay Humble
Entrepreneurism
Chapter Seven: Throw Away the Fundamentals and Stick to Your Charts
The Traditional Way
The Switch
Drury’s Core Principles
CNBC Interview
Crisis Times
Winners Always Adjust
Chapter Eight: Study Hard and Get an A+
Starting Out
Putting a System in Place
Big Picture Philosophical Points
Piling On
Chapter Nine: You Can’t Know Everything
Starting Out
Trim the Fat
You Have to Know Your Strategy
Chapter Ten: Make It Work Across All Markets
No More Suit and Tie
What’s the Magic Sauce?
Using a System
Fundamental Folly
Stories Don’t Make You Money
Motivation and Drive
Sheep Need Not Apply
Chapter Eleven: Stay in the Moment of Right Now
Take Advice
Responsibility
Human Nature
Old School Is Not New School
Find the Essence
Chapter Twelve: Sing the Whipsaw Song
Step Up or Step Down
Appendix A: Getting Technical: What Is Capitalism Distribution?
Appendix B: Fund Performance Data
Glossary of Key Terms
Author Disclaimer
Acknowledgments
More Praise for
The Little Book of Trading
“I strongly feel that you have to have three things present to be a successful investor/ trader: 1) you have to have mental discipline and control, 2) you have to carefully control risk and deal with various forms of portfolio management, and 3) you have to have a buy/sell strategy. In The Little Book of Trading, Michael W. Covel does an excellent job addressing what makes trend following such a successful strategy over time in most markets.”
—Tom Basso, Former President and Founder of Trendstat
Capital Management and author of Panic-Proof Investing:
Lessons in Profitable Investing from a Market Wizard
“The Little Book of Trading reveals the secrets of trend following insiders, giving you the freedom to trade all markets: interest rates, copper, currencies, stocks—you name it! Covel encourages you to take that TV blaring CNBC and throw it right out the window. Charts cut the noise.”
—Addison Wiggin, Bestselling author of
The Demise of the Dollar; Executive Publisher,
Agora Financial, LLC
“If you're in search of the big returns, buy and hold style indexing isn't going to cut it. In The Little Book of Trading, Covel profiles the managers that not only survived the GFC, they made fortunes on it.”
—Mebane T. Faber, Founder and Chief Investment Officer,
Cambria Investment Management
“In today’s global financial climate, where both stocks and bonds always sit at potentially very dangerous turning points, successful wealth management intent on ‘real, not relative’ returns requires a tactical trend following posture to asset ffirs.indd i 15/11/12 8:37 AM classes. This may be best achieved with the inclusion of a healthy allocation of managed futures. Covel nails it.”
—Arthur T. Doglione, Founder and President,
Alpha Fiduciary, Inc., Phoenix, AZ
“In The Little Book of Trading, Michael Covel has collected many gems of wisdom from some of the great traders of our time. After reading this book and icing together all of the commonalities therein, you'll begin to understand what it takes to be successful in the markets. Ignore these key truths and, one day, you'll watch your account disappear.”
—Van K. Tharp, PhD, President, The Van Tharp Institute
“Michael Covel is an expert in the field of trend following. His Little Book of Trading is an inside look at why top professional traders and fund managers are hugely successful. Highly recommended.”
—Mark Melin, author,
High Performance Managed Futures
(Wiley, 2010); Editor, Opalesque Futures Intelligence
“Michael Covel's unique insight into trading is invaluable. Both novice and experienced traders can benefit from Michael's thorough knowledge of markets around the globe. The Little Book of Trading is a must-read for serious investors.”
—Louis G. Navellier, Chairman and founder,
Navellier & Associates, Inc.
“Imagine being in the circle of trust of some of the greatest traders of all time, knowing what made them successful and having them share heartfelt advice. Through the eyes of Michael Covel in The Little Book of Trading, you will truly feel this experience.”
—Murray A. Ruggiero Jr., Contributing Editor, Futures Magazine;
VP, Research and Development, TradersStudio Inc.
Little Book Big Profits Series
In the Little Book Big Profits series, the brightest icons in the fi nancial world write on topics that range from tried-and-true investment strategies to tomorrow’s new trends. Each book offers a unique perspective on investing, allowing the reader to pick and choose from the very best in investment advice today.
Books in the Little Book Big Profits series include:
The Little Book That Still Beats the Market by Joel Greenblatt
The Little Book of Value Investing by Christopher Browne
The Little Book of Common Sense Investing by John C. Bogle
The Little Book That Makes You Rich by Louis Navellier
The Little Book That Builds Wealth by Pat Dorsey
The Little Book That Saves Your Assets by David M. Darst
The Little Book of Bull Moves by Peter D. Schiff
The Little Book of Main Street Money by Jonathan Clements
The Little Book of Safe Money by Jason
Zweig
The Little Book of Behavioral Investing by James Montier
The Little Book of Big Dividends by Charles B. Carlson
The Little Book of Bulletproof Investing by Ben Stein and Phil DeMuth
The Little Book of Commodity Investing by John R. Stephenson
The Little Book of Economics by Greg Ip
The Little Book of Sideways Markets by Vitaliy N. Katsenelson
The Little Book of Currency Trading by Kathy Lien
The Little Book of Stock Market Profi ts by Mitch Zacks
The Little Book of Big Profi ts from Small Stocks by Hilary Kramer
The Little Book of Trading by Michael W. Covel
The Little Book of Alternative Investments by Ben Stein and Phil DeMuth
The Little Book of Valuation by Aswath Damodaran
The Little Book of Bull’s Eye Investing by John Mauldin
The Little Book of Emerging Markets by Mark Mobius
The Little Book of Hedge Funds by Anthony Scaramucci
The Little Book of the Shrinking Dollar by Addison Wiggin
The Little Book of Bull’s Eye Investing by John Mauldin
The Little Book That Still Saves Your Assets by David M. Darst
Copyright © 2011 by Michael W. Covel. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at www.wiley.com/go/permissions.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.
For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002.
Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com.
Library of Congress Cataloging-in-Publication Data:
Covel, Michael.
The little book of trading : trend following strategy for big winnings / Michael W. Covel.
p. cm.—(Little book big profits series)
ISBN 978-1-118-06350-7 (hardback); 978-1-118-14388-9 (ebk); 978-1-118-14390-2 (ebk); 978-1-118-14389-6 (ebk)
1. Capitalists and financiers—Case studies. 2. Investments. 3. Investment analysis. I. Title.
HG4521.C815 2011
332.64—dc23 2011021445
This book is dedicated to my grandparents: Wesley Albert Kavaliauskas, Anna Lenore Margis, John Brooke Pruden, Jr., and Mary Margaret Wright
Introduction
A Wake-up Call
Ben Stein famously said, “If you didn’t lose a lot of money during the Panic of 2008, you were probably doing something wrong.” I heard those words and wanted to scream. His view could not be any farther from the truth. People made fortunes in 2008 with solid moneymaking strategies. The winners were not doing anything wrong, they just happened to have had the vision to prepare for the unexpected and when the big surprises unfolded—they cleaned up.
Investors have been conditioned for decades to believe that they cannot beat the market. They’ve been told to buy index funds and mutual funds, listen to CNBC, and trust the government. I have news for you. That does not work. We have all seen one market crash after another for the last decade. But the powers that be keep telling us that the old investing ways are the only way. Deep in our gut we know it’s not true. Even if we don’t know who the winners are, there are winners in the market, especially in the middle of a crash.
I am going to introduce you to a way of thinking, to a way of making money that is entirely different from what you have been taught. It varies vastly from what you have heard from the brokerage firms, the media, and the government.
First of all, you can leave fundamental analysis at the door. A lot of people are taught that fundamental analysis—knowing a company’s financial statement backwards and forwards in order to know where to invest, and crunching numbers until you’re blue in the face—is the cornerstone of investing. Well, you do not need to know how great the demand will be for the next Apple iPad. You do not need to know how far gold will go up, or down, or why. The only variable to understand, so you can make money, is to know which way the market is trending, and if you are on board, up or down, you go in that direction.
This book is all about trend following trading. Maybe you’ve never heard of it. Trend following is real simple. Pretend you have no idea which way a market will go or for how long. Trend followers simply say that if Apple is trading at 300, and it starts to go higher, they will buy Apple. Why would you do this? If Apple is going up you want to be on board. Period. No one knows how high or low Apple may go, but if it goes from 300 to 400 you don’t want to miss out—even if 300 feels like too high a price to buy in at. Buying low or cheap is not the goal.
The greatest thing about trend following is that you do not have to know anything about oil. You don’t have to know supply and demand for next week or next year. Trend followers don’t care. If the market is going up—you buy. After you buy, if it goes the other way and you start to lose money—you get out. How do you know to get out? Trend followers abide by certain universal and timeless rules that go way back. One major rule is accepting when you are wrong in the market and getting out. You need to be willing to lose a small amount of money if the trend does not go your way. The key to keeping that loss as small as possible is admitting defeat. This is how you preserve capital.
Let me break it down. Let’s look at Apple again. Assume it is at 300. It goes to 310 and you buy. You hope it will go to 400, but you don’t know if it will. So when you buy Apple at 300 you say to yourself, “I am only willing to lose 5 percent of my money” (just an example to bring you in). If you have $100,000 and invest all of it in Apple, then you are willing to lose $5,000 while hoping the trend will go to 400. If Apple starts to go down and you lose $5,000, you get out. That’s it. That is trend following in a nutshell. If it doesn’t go down, and you don’t lose $5,000, you stay along for the ride for as long as it goes.
Another wrinkle to trend following? Not only can you make money when markets go up, you can make money when markets go down. You can go “short” when the trend is down, profiting for as long as markets remain in that direction. This means you can make the same amount of money when Google goes from 600 to 700 as when it goes from 700 to 600.
It’s not just stocks. Trend followers apply their “know nothing about a market” to currencies, commodities, bonds, gold, oil—you name it. You do not have to know the name of the market to trade it. Trend
traders only care which way the market price is moving so they can get on the train. Or think of yourself as a stowaway on a cruise ship to the islands. Why do you care how the ship gets there? You are already on board. Let someone else worry about the particulars of navigating the ship. Do the top traders really think and act like this? You bet.
Not only did trend following traders make money in 2008, but they’ve been making it big for decades. Why have most people not heard of this great alternate trading strategy that makes money in bull and bear markets? Why are people not familiar with this moneymaking strategy that performs well during chaos?
One answer: mutual funds.
We have become a world seduced by the idea that you can buy and hold a mutual fund for a lifetime, rewarding you with a huge nest egg when retirement sets in. The vast majority of investors have been sold that pipe dream by the mutual funds themselves. And, they hire serious lobbyists in Washington, D.C. Do you really believe mutual funds are a good idea after a decade of no returns, while simultaneously the owners of mutual funds have made billions?
Let’s not dwell there though, since this book doesn’t waste much time on bashing the competition. This book is about showing and proving that there is a way you can still take your legitimate shot at making the big money. I am going to introduce you to the strategy of trading trends the best way I know how: through the insights of some of the most successful trend following traders alive. Why should you care about these traders?
For one, they are real people performing real trades. They are not CNBC talking heads. They are not academics. They are not politicians. They do not make predictions. They do not make outlandish claims. They simply make money. How do you know for sure they make money? How do you know they are real? Their audited track records are on file with the United States government (and in Appendix B).
Still asking why this is all relevant to you and your account? I have been teaching, writing, and researching this subject since 1996. The number one reason people fail to adopt trend following trading, or fail to understand it, comes down to education—more specifically, the lack of it.
I have learned that when you expose people to the subject of trend following, introducing readers and students to real winning traders furthers the learning curve by leaps and bounds. Not the shiny PR bios, but real behind the scenes life stories and strategies. If you can go behind the curtain of the greats and even a few newer traders, if you can relate to their upbringing and values, if you can relate to their struggles, you are going to be in a much better position to grasp and utilize trend following strategies for your own account. Better yet, by allowing yourself to feel their lives, you will also begin to see that they all have much in common with all of us.
The Little Book of Trading Page 1