Thursday, July 28, 2011

Feld & Mendelson, Venture Deals

Brad Feld and Jason Mendelson wrote Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist (Wiley, 2011) primarily for the entrepreneur who’s thinking about taking his start-up to the next level—accepting venture capital. It’s a hands-on book that goes a long way toward leveling the playing field between entrepreneurs and VCs. And no, the entrepreneur can’t fire his lawyer after reading this book, but at least he doesn’t have to be obsequious.

The authors focus on the term sheet, which is a summary document in contemplation of a financing. It has two key elements: economics and control. That is, what is “the return the investors will ultimately get in a liquidity event, usually either a sale of the company or an initial public offering”? And how much control can the VCs have over the company’s business decisions?

These questions would appear to be straightforward, but of course they’re not. The subheads in the chapter on the economic terms tell part of the tale: price, liquidation preference, pay-to-play, vesting, employee pool, and antidilution. And, trust me, even if you think you understand the concepts in the subheads, it gets a lot more complicated as you drill down.

Although the term sheet gets the lion’s share of the book’s attention, including a sample term sheet in an appendix, the authors also explore other areas vital to entrepreneurial success, such as negotiation tactics and raising money the right way.

All in all, if you are thinking about looking for outside capital for your business, you should definitely read this book. If you are a wannabe VC, it’s also important. I, who fall into neither category, found it a fascinating read.

Tuesday, July 26, 2011

Toghraie, Trading on Target

For those who are struggling with self-sabotaging problems that undercut trading profitability (and isn’t everybody?) Adrienne Toghraie’s Trading on Target: How to Cultivate a Winner’s State of Mind (Wiley, 2011) offers advice. The advice isn’t revolutionary, it’s often perfunctory, and I’m not even sure it’s always sound—at least not if one believes some recent psychological studies. But it is far-reaching, so the reader will most likely find out something about himself that he didn’t realize before, something that is holding him back from reaching his full potential as a trader.

The book is divided into five parts: obstacles to becoming a top trader, letting go of emotional states, taking right action, stretching and expanding yourself as a trader, and modeling top traders. Many of the discussions are illustrated with case studies. Let me start with my favorite, meant to lend color to the claim that “a detailed mental image is one of the most powerful tools that a trader can have. An individual with a clear vision of himself as a trader, with positive detail and without misgiving, is truly a trader.” (p. 217)

The author attended a party where the host’s children entertained the guests with piano performances. The oldest girl sat down at the keyboard with tremendous confidence, performed brilliantly, bowed, and identified the piece she had just played. Her younger brother went through the same motions and, although he was not the equal of his sister, played the best that he could. “The third child to entertain us was another girl, who was only four years old. She approached the bench with the same confidence as her older brother and sister. She paused before her performance and with focus that was equal to her older siblings, raised the pointer finger on her right hand and pressed the key of Middle C. Then, she stood up, bowed with a flourish and announced, ‘The name of my piece is “Middle C.”’ We all applauded her enthusiastically because she had also done the best she could.” The author continues: “The best for her was the knowledge that the picture she had in her mind would manifest itself in time.” (p. 214) Well, maybe yes and maybe no, but she sounds like a corker who will probably make her mark somewhere.

Toghraie's book addresses difficulties that traders at all levels of experience and competence face. Take “The Happy Monkey,” for instance. Rex (who really should have been given a different name) spent a long time developing a trading system and paper trading it before he finally committed money to it. Six months into his trading he was doing very well; two months later he was “second-guessing his system and losing money.” (p. 175) Rex the tinkerer was bored. He lamented that he felt like a mindless monkey who simply pulls the lever when the signal tells him to pull it.

The author suggests two paths for Rex. First, he can re-channel his need to tinker, either by working on an alternative system (presumably after trading hours) or finding some intellectually challenging outlet outside of trading. Second, he can become the happy monkey. That is, he can create a new internal model that redefines his role, goals, and rewards. “The new picture was of a person who had accomplished the tinkering in the past, but now had permission to follow his rules. The picture comes with the understanding that there is a prize out there for following his rules. That prize is that he will be the person who adds value when he has mastered his technique and can use his intuition as a new filter. Having permission to use intuition in his trading is a treasure, indeed, because it allows Rex the ability to use his mind again in a way that is constantly challenging and new each time. However, he cannot use the intuition filter unless he has mastered his technique and mastered his own psychology.” (p. 178) The trick, of course, is to differentiate between using intuition and second-guessing.

Adrienne Toghraie is a trader’s coach who, on her website ( advertises her home study course, seminars and workshops, and private coaching—all on the expensive side. For most traders who want access to her ideas, I suspect reading Trading on Target will suffice. For those in search of a coach, the book is an easy way to decide whether Toghraie belongs on the short list.

Monday, July 25, 2011

Bern, Investing in Energy

I was looking forward to Gianna Bern’s Investing in Energy: A Primer on the Economics of the Energy Industry (Bloomberg/Wiley, 2011). My knowledge of the energy complex was haphazardly gleaned, so I thought a primer would be just the thing to pull all the fragmentary bits and pieces together. Ultimately, I was disappointed. Although the book is packed with information, the author’s disjointed, sometimes opaque, and often repetitive prose keeps getting in the way. I suspect that the author, who is the president of Brookshire Advisory and Research, simply knows too much and found it difficult to tell a simple, straightforward story.

The book covers crude oil and natural gas, the power sector (hydroelectric, nuclear, geothermal and wind, solar), and green energy (biofuels and ethanol, cleaner coal). Understandably, given its dominance in the energy markets, crude oil is the focal point of the book.

We read, for instance, about categorizing (not the highly technical task of measuring) reserves into the proven, the probable, and the possible. Proven reserves have a 90% certainty of being produced; probable reserves, a 50% certainty; and possible reserves, at least a 10% certainty. For some strange reason, the industry isn’t satisfied with this breakdown into P90, P50, and P10. Instead, it offers an aggregating typology: 1P reserves are proven, 2P reserves are the sum of proven and probable, and 3P reserves are the sum of proven, probable, and possible. “Why report 2P or 3P reserves if they are, by definition, unproven? Oil and gas producers report 2P and 3P reserves because they provide a picture as to future potential oil and gas reserve growth.” (p. 55)

Readers who thought they knew what the crack spread was will discover that, as is so often the case in the energy complex, nothing is definitive. The most familiar 3-2-1 crack spread “considers the theoretical profitability of refining three barrels of crude into one barrel of heating oil and two barrels of gasoline.” Since there are 42 gallons in a barrel, the formula is [(1 x HO price x 42) + (2 x RBOB price x 42) – (3 x crude price)]/3, where HO is the symbol for heating oil and RBOB for “Reformulated Blendstock for Oxygenate Blending base grade of gasoline.” (p. 91) (Sounds like a good Jeopardy question to me!) But since seasonal factors weigh on the relative demand for gasoline and heating oil, sometimes it makes sense to look at 1-1 spreads—the heat crack and the gas crack. And outside of the U.S., where diesel often takes the place of gasoline, other ratios—such as a 5-3-2 crack spread--are more commonly used.

The author covers a range of topics critical to understanding oil production, refining, and pricing. One of the more interesting chapters to me, since I’ve been following the ups and downs of the Hungarian oil company MOL, analyzes state-owned and mixed-capital oil companies. Successful examples of the latter are Statoil (Norway), Petrobras (Brazil), and Ecopetrol (Colombia).

Investing in Energy is a blend of information, analysis, and investing advice. It attempts too much and therefore fails as a primer. But for anyone who wants to know what he should know about the energy complex, it’s a good jumping-off point.

Thursday, July 21, 2011

Beder and Marshall, Financial Engineering

Financial Engineering: The Evolution of a Profession, edited by Tanya S. Beder and Cara M. Marshall (Wiley, 2011), is part of the Kolb Series in Finance and, like its predecessors, is a big book—some 600 pages long. It is a fascinating collection of 29 original papers written by both academics and practitioners.

Two articles outline career opportunities and educational programs for aspiring financial engineers. The rest of us can home school ourselves from the comfort of our own favorite reading nook. The curriculum? In addition to a brief history of financial engineering, the volume deals with such major themes as financial engineering and the evolution of major markets (fixed income, U.S. mortgage, equity, foreign exchange, commodity, and credit); key applications of financial engineering; case studies in financial engineering—the good, the bad, and the ugly (mostly ugly); and special topics in financial engineering.

Financial engineering may be the stomping ground for quants, but you wouldn’t know it from this book—at least not until the first appendix that describes some IT tools for financial asset management and engineering. The book has virtually no math in it; aside from a few figures, charts, and graphs, the authors rely on good old-fashioned prose, most of it quite lucid, to explain the many facets of financial engineering.

I tried to decide what to share in this review. I contemplated the piece on portable alpha because I was thinking just the other day about what ever happened to this once hot concept. (Apparently it may see a rebirth in a more robust and dynamic form.) I ruled out the chapters on quantitative trading in equities and systematic trading in foreign exchange because we’ve touched on these topics, at least in their general form, often enough on this blog. I finally decided to wade into new waters—financial engineering and macroeconomic innovation, a paper by Cara M. Marshall and John H. O’Connell.

We know that some U.S. municipalities are in severe financial straits, even if the situation is not as dire as Meredith Whitney would have us believe. Take the case of Harrisburg, which faced default on its incinerator bonds and had to be bailed out by the state of Pennsylvania. Given the cyclicality of the economy, why didn’t Harrisburg simply have a rainy day fund? The authors concede that “surpluses are hard to justify as they lead to pressure to either “(1) increase spending, (2) cut taxes, or (3) some combination of the two.” But, they suggest, “macroeconomic derivatives could easily represent a powerful, albeit partial, solution to this problem. Using historic data, a city like Harrisburg should be able to determine how changes in national or regional GDP growth impact its cash flows. Alternatively, it might do the analysis using the national or a regional growth rate in non-farm payrolls. The city could then enter into a GDP or non-farm payroll swap.” The goal would be to “keep the city’s budget balanced in all economic climates.”

Let’s say that the budget is balanced when real GDP grows at 2.7% and that a 1% change in GDP translates into $20 million of net cash flow (in or out) for the city. The city could enter into a 10-year GDP-swap with a macroeconomic swap dealer. In its simplest form, disregarding any spread, the deal could be structured in such a way that “the city pays the swap dealer the actual annual growth rate in GDP on notionals of $2 billion and the swap dealer pays the city an annual fixed rate of 2.7 percent on the same $2 billion of notionals.” Suppose the GDP increases to 3.7%. Then “the municipality would pay the dealer $74 million (i.e., 3.7 percent x $2 billion), and the swap dealer would pay the city $54 million (i.e., 2.7 percent x $2 billion). In a swap, only the net is exchanged with the higher paying party paying the lower paying party the difference. So, in this case, the city pays the swap dealer $20 million—which is precisely the size of its surplus for the year. On the other hand, suppose that the following year the economy sinks into a recession and GDP growth becomes negative, say -1.3 percent. Then, the swap dealer will pay the city $26 million on the GDP leg. (This is because the payment on the GDP leg is negative, so it goes in the opposite direction.) And the swap dealer also pays the city $54 million on the fixed leg. Thus, the city receives an infusion of $80 million from the swap dealer thereby offsetting its cash flow shortfall caused by the decline in GDP (i.e., the recession).” (pp. 301-302) Another solution would be to structure municipal debt offerings along the lines of inflation-indexed bonds with a floating coupon that would be tied inversely to the growth rate of the GDP.

There’s always room for financial innovation, and Financial Engineering offers its share of ideas. It also provides ample documentation of the unintended consequences of innovation gone awry. All in all, a thought-provoking read.

Tuesday, July 19, 2011

Sullivan, Clutch

Paul Sullivan’s Clutch (Portfolio/Penguin) was published last year. Sullivan, a business columnist for The New York Times, looks at why some people thrive under pressure while others choke. He illustrates his points with well-drawn portraits of people who are “clutch.” Some of these clutch performers, such as Jamie Dimon and trial lawyer David Boies, are well known public figures; others, such as Sgt. Willie Copeland, are not. But all have demonstrated that they can perform exceptionally well in the most trying circumstances.

What traits do the clutch performers share? Sullivan identifies five: focus, discipline, adaptability, being fully in the present, and being driven by fear and desire.

Let’s look at some case studies. First, David Boies on “entering the bubble.” Boise prepares, prepares, and prepares even more for a trial. Once the trial begins he focuses. “In the courtroom, he said he not only has no idea how the trial is going on a broader level but he does not care. … If Boies stopped to congratulate himself on a particularly deft cross-examination or tried to tally up where he stood, he would lose his focus. … He is concerned more with tangible measures. Is the argument he is making working? Is it true and will it hold up under scrutiny from the opposing lawyer? … His focus does not make him myopic. It allows him to follow the tack that he or his opponent is taking at that moment and recalibrate his argument. That is what he can control.” (pp. 41-42)

Second, the importance of discipline and resilience in trading as related by William Mumma, global head of derivatives at Bankers Trust in the mid-1990s. “There were two reasons people got A’s at Harvard or became Navy Seals, and only one of those reasons made them good traders. Some prepared and studied harder, which would not necessarily help them. They did not expect to lose ever—in life, in school, in work. This was not possible in trading. But others [who got A’s after faltering along the way]… were innately better at pushing themselves to succeed. They didn’t fear failure; they hated it,” which, as Mumma was quick to point out, is different from disliking losing. “All traders lose at some point, but it doesn’t mean they failed. It means they lost on a particular day. The better traders figured out how to avoid losing strategies, those that not only lead to losses in a single day, but failure down the road.” (pp. 66-67)

Finally, the power of fear as a motivator. In 2007 researchers studied 281 students at the University of Bath, two-thirds of whom went to the gym regularly. They wanted to figure out what motivated some students to work out and others not to. The study was something of a thought experiment. The researchers “asked half of them to imagine themselves as overweight and unattractive. The researchers then further divided the sample by asking half of the group to imagine themselves failing at their workout regime—and thus becoming even less attractive—while telling the other group to see themselves succeeding wildly and in doing so becoming much more attractive. Over the course of the study, the researchers found that the group that was motivated by the fear of looking awful stuck to their workout better than the group that was doing it with the hope of looking better. The gap between the two groups was significant, with 85 percent who wanted to avoid becoming unattractive continuing their workouts when told they were failing compared to 65 percent who were told they were succeeding. Even if both groups started out going to the gym regularly, the ones that were doing it to look better than they already did dropped off, while those who felt, in essence, that they had to dig themselves out of a hole were the ones who continued.” (pp. 117-18)

Monday, July 18, 2011

The CRB Commodity Yearbook 2011

Commodity traders, especially those who trade at least in part on fundamentals, recognize that the CRB commodity yearbooks are an invaluable resource. No, they don’t come cheap, and now that they are sold exclusively through the Commodity Research Bureau they are even pricier. But consider what you get for your money: 384 8 ½” x 11” pages, most filled with charts and tables (over 900 in all).

If I counted correctly, the yearbook covers 104 commodities, from aluminum to zinc. In addition to the exchange-traded commodities we’re all familiar with, there is somewhat perfunctory introductory information and data on such products as cassava, castor beans, eggs, honey, lard, plastics, rayon, and tallow and greases.

I happen to be fond of tapioca, whose primary source is cassava. So I was a tad distressed to learn that “one problem with cassava is the poisonous cyanides, which need to be destroyed before consumption.” At least we don’t eat castor beans (though there is the dreaded castor oil) since the potent toxin ricin is found naturally in them. But did you know that, according to the USDA, “a diet of whole milk and potatoes would supply almost all of the food elements necessary for the maintenance of the human body”? And those who think that onions add to the flavor of food paid for their culinary opinion last year: average onion prices in 2010 were up 108.3% over the 2009 level.

These tidbits of information are not actionable for a trader, but the massive amount of data in the yearbook, most covering the decade from January 2001 through December 2010, certainly should be. Where seasonal factors have an impact on commodity prices, there are monthly data. Otherwise the tables offer detailed yearly data.

Consider, for example, cotton, which was on a tear in 2010. The yearbook devotes eight pages to the commodity and provides the following tables (most covering a decade): supply and distribution of all cotton in the United States; world production of all cotton; world stocks and trade of cotton; world consumption of all cottons in specified countries; average spot cotton prices, C.I.F. Northern Europe; average producer price index of gray cotton broadwovens; average price of SLM 1 1/16”, cotton/5 at designated U.S. markets; average spot cotton, 1 3/32”, price (SLM) at designated U.S. markets; average spot prices of U.S. cotton, base quality (SLM) at designated markets; average price received by farmers for upland cotton in the United States; purchases reported by exchanged in designated U.S. spot markets; production of cotton (upland and American-pima) in the United States; cotton production and yield estimates; supply and distribution of upland cotton in the United States; average open interest of cotton #2 futures in New York; volume of trading of cotton #2 futures in New York; daily rate of upland cotton mill consumption on cotton-system spinning spindles in the United States; consumption of American and foreign cotton in the United States; exports of all cotton from the United States; U.S. exports of American cotton to countries of destination; cotton government loan program in the United States; production of cotton cloth in the United States; cotton ginnings in the United States; fiber prices in the United States. Whew!

Is the CRB commodity yearbook essential for those who trade technically? No. Could their trading be improved by including some fundamental data? Most likely. At the very least, the yearbook provides fodder for hypothesis generation. And for macro traders, even those who may not always be in the commodity markets, it’s a treasure trove of leads. It’s a book I know I will return to again and again.

Friday, July 15, 2011

Martinez, The Forex Mindset

Jared F. Martinez’s The Forex Mindset: The Skills and Winning Attitude You Need for More Profitable Forex Trading (McGraw-Hill, 2011) is meant to be an uplifting book—part pep talk, part sermonette—that is directed at all traders. I think that Forex may be mentioned more often in the title and subtitle than in the text itself.

Much of the book is derivative, some of it is banal. We read such nostrums as “For every minute you remain angry, you give up 60 seconds of happiness.” (p. 122) Or “If we don’t stand for something, we have the potential to fall for anything.” (p. 93) Some quotations get badly mangled. For instance, C. S. Lewis wrote: “Humility is not thinking less of yourself but thinking of yourself less.” Martinez writes (p. 168): “Humility is thinking less of yourself rather than thinking of yourself less.” I don’t think so.

In fifteen chapters Martinez tries to help the reader with such things as finding a mentor in trading and in life, understanding how your head and heart work, the importance of change, dealing with frustration and anger as you trade, learning patience and self-control to avoid temptation, listening with humility, learning to trade with confidence, and achieving excellence at trading.

Here are a couple of his recommendations.

There are eight elements of excellence “that can guide you from the dream of excellence to the actual end result of daily applied excellence. 1. Work with purpose and with passion. … 2. First identify questions, and then find answers. … 3. Be clear about your purpose. … 4. Venture from your comfort zone. … 5. Strive for perfection, but aim for excellence. … 6. Take risks, and never give up your right to be wrong. … 7. Respect yourself and each other. … 8. Search for excellence as you strive to keep perfection in perspective.” (pp. 46-48)

“The biggest temptation most traders fight is the temptation to settle for too little. Some traders succumb to the temptation of settling for too little. … Every trader must find a balance between settling for too little and wanting too much.” (p. 158)

If you’ve never encountered a self-help book before, this might be a reasonable place to start. If you want to track down proverbs that aren’t referenced as such, it might be provide a few hours of diversion. (For instance, the author writes that “A handful of patience is far more valuable than a barrel of brains.” This didn’t sound like something he dreamed up, and—indeed—it turns out to be a Dutch proverb.) But The Forex Mindset is definitely not among the most useful books on trading psychology that I’ve read.

Wednesday, July 13, 2011

Free special issue of Expiring Monthly

I wrote last month about the options journal Expiring Monthly. For those who like to sample before making a commitment, a special issue with highlights from volume one is now available for free download (and no form to fill out). Both Condor Options and Option Pit have the download link.

Tuesday, July 12, 2011

Bhuyan, The Esoteric Investor

If you’re bored with the standard investing vehicles and want to cast a wider net (pun intended), Vishaal B. Bhuyan’s The Esoteric Investor: Alternative Investments for Global Macro Investors (FT Press, 2011) has three suggestions: demographics, fish, and water.

The author’s specialty is longevity and mortality risk instruments such as life settlements, reverse mortgages, and longevity reinsurance. He edited Reverse Mortgages and Linked Securities, which I reviewed earlier. In The Esoteric Investor he writes about the so-called life markets in the context of the looming demographic crises, with Japan being the poster child for potential demographic disaster.

I was most intrigued, however, with the second part of the book on tuna. I remember being stunned when I read a while back that a 754-pound bluefin tuna had fetched a record $396,000 at the world’s largest wholesale fish market in Tokyo. That’s a whopping $525 a pound! Talk about tunamania!

I didn’t know how these bluefish tuna went from being mere glints in their mother’s eye (actually, a mature female lays millions of eggs over a period of months—and a good thing because it has been estimated that fewer than one in a million survives) to a very high-priced course at a top Tokyo or New York restaurant. Here’s how tuna fishing and fattening goes in Australia, the prime supplier of high-end tuna to Japan.

Southern bluefin tuna are born in Indonesian waters. “For the next eight years, they leisurely work their way around the west coast of Australia, crossing the Great Australian Bight en route to the east coast.” The best-case scenario is that they will circumnavigate Australia and return to their birthplace to spawn and begin the cycle anew. “But many will not make it that far. They will pass unscathed through Western Australian waters and the Great Australian Bight, but then they will find that their migration route has brought them into the perilous seas off South Australia, where boatloads of fishermen with nets are dedicated to keeping them from completing their instinct-inspired journey.” (p. 88)

After spotter pilots locate schools of tuna and radio their location to the waiting “chum boats,” the fishermen on these boats throw baitfish into the school, “causing the tuna to become excited and follow the boat.” Then “a net is shot around the school of fish and the chum boat. The spotter pilot overhead directs the boat out of the net just before it closes, leaving nothing but fish behind. The net is pursed around the school, perhaps thousands strong.” The trapped tuna are then transferred to a net cage, similar to a floating corral, which tows the fish to one or more of 150 pens off Port Lincoln. Each pen contains from 20 to 50 tons of fish.

“These tuna are a precious commodity—which is exactly the right term—and they are pampered and coddled to an extent that would embarrass a purebred Pekingese. Every day of the year, the bait boats make the 5-mile journey to the pens around 6 a.m. and then return to the Port Lincoln marina to pick up another consignment of baitfish to feed the penned tuna. At 2 in the afternoon, they do it again. Stehr Group feeds 60 tons of pilchards a day to their tuna; over the season that adds up to 5,500 tons.” (p. 86)

The tuna are kept in these fattening pens for several months until they are big enough to be slaughtered. No need to go into the gory details here. And then off to the Tsukiji tuna auctions.

Well, I obviously got hung up on tuna—and I didn’t even write anything about the problems of overfishing and other ecological concerns—and have neither time nor space to do justice to the book as a whole. Perhaps at a later date I’ll do another post on it because it is an intriguing book. Most of the investing opportunities are not for the retail investor (water being the exception), but they’re interesting to read about nonetheless. Maybe someday we’ll get a fish ETF or futures contract in the U.S.; Norway’s fish exchange (FISH Pool ASA) launched a salmon futures contract back in 2007 and traded over 100,000 tons in 2010. The ticker FISH isn’t taken yet.

Monday, July 11, 2011

Baiynd, The Trading Book

Anne-Marie Baiynd is a thoroughly engaging writer. The Trading Book: A Complete Solution to Mastering Technical Systems and Trading Psychology (McGraw-Hill, 2011) may not be the greatest thing since white bread, but it’s a darned good read.

As the subtitle indicates, the book moves between the nuts and bolts of a discretionary technical trading plan and—dare I go there?—the nuttiness of the unprofitable trader. She walks the reader through a series of trades that, in their full complexity, rely on analyzing candlesticks, moving averages, Fibs, and Bollinger bands. And she proves that one can actually describe trades in clear, cogent prose. The discretionary trader who uses some or all of these tools will learn their subtleties. The person who doesn’t know what tools to use will get a good sense of how to begin to structure trades, piece by piece.

In this review, however, I’ll focus on a couple of psychological takeaways from the book.

Let’s start with the trading journal—that thing that every trader knows he should keep and yet so few do. The author admits that initially she herself put the task of creating and using a trading journal on an “I’ll eventually get around to that” list. She writes: “I resisted the urge early on because it seemed like a lot of work that would actually interrupt my trading, then I resisted because I did not know what to write down, then because I felt a bit lazy, and then because the last thing I wanted to do was review horrifying trades to remind me about how bad I was.” Eventually she came to the realization that “what I had been doing had given me what I had gotten, and since I didn’t like the state I was in, writing a trading journal (as well as a lot of other changes) started looking really good to me.” (pp. 135-36)

She recalls that “the months of journal writings chronicling major defeat were gut-wrenchingly emotional, ramblings of a trader at her wits’ end, but every day I just kept coming back. About every six weeks, I’d break them out and read over the past trades, and though the queasy feeling stayed reading many of them, it was invaluable—like a road map in the dark and a chance to review actions with a mind no longer clouded by the emotions of that day. Reading my old trades and talking them out loud was critical to my advancement as a trader.” (p. 142)

One of the things that traders have to confront in their journals is the incredible difficulty of sticking to their system or plan. “Trading is a bit like this. We are playing a game where we have, let’s say, three doors from which to choose. Behind the first door is a man wearing a set of brass knuckles, and he’s waiting to deliver a shot to the face; the second door is our brokerage firm, which will take a transaction fee for simply opening then closing the door; and the third is a lovely knapsack full of Benjamins. Every time we open a door and close it, our items shift around between doors.” (And you thought we were simply dealing with the Monty Hall problem!) We have a system that is very reliable if well executed. So we put on our first trade, choosing door number one. We encounter “Knuckles”—definitely no fun. Our next trading signal sends us to door number one again. Do we really want to open that door again? Of course not. But we muster up the courage and open the door, unfortunately later than we should have—“and there’s Mr. Broker fleecing our pockets.” You get the picture.

Baiynd continues: “If we choose to day-trade or to swing-trade … , the scenario just described is a large measure of our daily existence, and how we fare has far more to do with our abilities to follow direction, address fear, and manage our exposure than any system out there.” (pp. 48-49)

Since we’re all to varying degrees flawed traders, reading some of the ways to confront our failings is an important first exercise. The Trading Book makes that exercise exceedingly palatable.

Sunday, July 10, 2011

Happy birthday, blog

Hard to imagine, but Reading the Markets has now been up and running for two years, with almost 600 posts. Some days I swear I’m going to shut it down because it is so much work, but then a publisher dangles an irresistible carrot of a book. . . .

By the way, I found the image on Deborah Melmon’s blog, Deb’s Art—lots of amusing illustrations.

Friday, July 8, 2011

Covel, Trend Commandments

It’s time for a beach book, and Michael W. Covel’s Trend Commandments: Trading for Exceptional Returns (FT Press, 2011) fits the bill perfectly. The many, many “chapters” are bite-sized, and there are mighty few intellectual challenges to get in the reader’s way as he turns pages faster and faster. The thesis is familiar: trend following is the surest path to trading success. Very little how-to, lots of passion about trading and living an engaged, courageous life. And spiced up with swipes at the likes of Warren Buffett. As I said, a beach book—and therefore one that is difficult to review in a meaningful way.

So, instead, let me pull out three passages, not all Covel’s original ideas, that I think are worth quoting in part.

First, footnoted to Ed Seykota’s website but in Covel’s prose: “All trends are historical. None are in the present. There is no way to determine a current trend, or even define what current trend might mean. You can only determine historical trends. … [T]he only way to measure a now trend, one entirely in the moment of now, would be to take two points, both in the now and compute their difference.” (p. 39)

Second, on figuring out when to get out of a trade, compliments of Peter Borish: “You need a prenuptial agreement with the market.” (p. 75)

Finally, from the “chapter” on statistical thinking, “Trend following is about non-normality of market returns. You will never have, nor will you ever produce, returns that exhibit a normal distribution. You will never produce the mythologically consistent returns that many believe to exist. … Trend following’s alpha comes from letting winners run on the right-hand side of a fat tail and cutting losses short on the left-hand side. Eliminating losing positions and holding onto profitable positions puts you in the big game hunt for positive outliers. A normal distribution is simply worse than useless as a risk management tool.” (p. 137)

Wednesday, July 6, 2011

Fischer, Trading with Charts for Absolute Returns

Robert Fischer, author of Fibonacci Applications and Strategies for Traders, The New Fibonacci Trader, and Candlesticks, Fibonacci, and Chart Pattern Trading Tools has a new book out: Trading with Charts for Absolute Returns (Wiley, 2011). In it he explains chart pattern recognition, especially Fibonacci and Elliott wave principles; trend channels and trend lines; and, his ultimate weapon, the PHI-ellipse. The PHI-ellipse must be computer generated and is available as part of Fischer’s Fibotrader software package ( The software can be used free as long as the user is willing to import .ascii data manually.

Although the book clearly promotes the software package, it offers quite solid tips on how to work with support and resistance lines—and, among other things, use false breakouts to one’s advantage. The author identifies patterns such as support lines based on three valleys and a false breakout and its counterpart, resistance lines based on three peaks and a false breakout.

The PHI-ellipse is not a new trading tool (the author introduced it already in 2001), but it has taken Fischer time to develop trading rules based on it. So what is it? As you might imagine, it is an ellipse where “the ratio of the major axis divided by the minor axis of the ellipse is a member of the PHI series 0.618 – 1.000 – 1.618 – 2.618…. A circle, in this respect, is a special type of PHI-ellipse with a = b (ratio a:b = 1).” But, without tinkering with this ratio, there’s a problem. “PHI-ellipses with increasing ratios ex = a:b of major axis to minor axis turn very quickly into ‘Havana cigars’—and … become so narrow that they can hardly be applied to charts as an analytical tool. … To make PHI-ellipses work as tools for chart analysis, the mathematical formula that describes the shape of the ellipse is transformed. The ratio of the major axis a to the minor axis b of the ellipse is still under consideration, but in a different way—in mathematical terms, ex = (a:b)x.” (pp. 142-43)

What makes the PHI-ellipse so special? It is a trend-following trading tool designed to keep the investor in the trending market as long as possible. It integrates price and time into a single tool and can dynamically adjust to price moves. On the downside, it cannot be part of a fully automated trading system.

Fischer takes the reader through the best peak/valley structures for drawing the PHI-ellipse and offers rules for trade entries. And he, of course, directs the reader to the companion web site. The software is free to download for a 15-day trial; afterwards, if you don’t pony up the subscription fee, it turns into an .ascii-only data program.

Tuesday, July 5, 2011

Light, Taming the Beast

Larry Light’s Taming the Beast: Wall Street’s Imperfect Answers to Making Money (Wiley, 2011) is perfect summer reading fare. The author, a financial reporter and editor, is a skilled storyteller. In this book he explores a range of investment strategies and instruments, traces their development, and in the process profiles some of the best-known investors and academics.

He covers value investing (Benjamin Graham and Warren Buffett), stocks (Jeremy Siegel), indexes (John Bogle), bonds (Bill Gross), growth investing (Thomas Rowe Price), international investing (John Templeton), real estate (Donald Trump), alternatives, asset allocation, short selling (James Chanos), hedge funds (Alfred Winslow Jones and Steve Cohen), and behaviorism (Daniel Kahneman and his followers).

Light’s thesis is that “investing success does not come in one flavor” and that “the trick is to be sufficiently flexible to dip into any or all of [the approaches he describes], but by the same token, to know their limitations.” (p. 254) He does a good job of spelling out these limitations. Even for more experienced investors who are well aware of many of these limitations, Little’s prose is so quick-paced that the book should be read, not skimmed.

Take, for instance, the case of a $50 short gone bad. “Maybe XYZ’s rivals trip over themselves and the company’s management gets its act together. Amid joyous shouts on Wall Street, XYZ vaults to where the air is rare, hitting $100. Your broker will want you to put up more margin, often an extra 30 percent of the value. Worse, you have an unlimited liability. The damn XYZ stock could keep on levitating. The higher it flies, the more you are out of pocket to buy it back. For you, this is a real nightmare on Wall Street, with the broker playing the role of Freddy Krueger.” (p. 203)

Or take real estate, “a realm of cruel ironies.” Think back to the building frenzy in Dubai with the 2,717-foot-tall Burj Khalifa (its post-bailout name) viewed as the “crown jewel” of Dubai. Although this skyscraper was 90 percent sold, “other Dubai commercial structures stood forlorn. … That left the Burj as a massive mockery of the promise that real estate was a gift that kept giving forever.” (p. 140)

And, on a stroll down memory lane, think back to when Hillary Clinton “parlayed a $1,000 grubstake in cattle futures into $100,000 over 10 months. … When her trading success came to light in 1994, with the Clintons in the White House, there were dark mutterings that she must have cheated somehow. The editor of the Journal of Futures Markets was quoted as saying: ‘This is like buying ice skates one day, and entering the Olympics one day later.’ But no malfeasance was ever proved. Most likely, Hillary Clinton was preternaturally lucky.” (p. 169)

The cast of characters in this book is vividly described. “Known for his brightly colored bow tie and unorthodox enthusiasms” could refer only to Jim Rogers. And you may recall that Bill Gross “reacts to mistakes seriously. After a bad call on junk bonds, he took a sabbatical of several months to clear his head. His wife told the New York Times that he once recommended a Pimco fund to the owner of his local doughnut shop and, when it lagged for a while, ‘he could hardly go in the shop for his favorite coconut cake doughnut.’ “ (p. 97) I was surprised to read that he actually eats doughnuts.

All in all, Taming the Beast is a delight to read, especially in comparison to so many of its very dull competitors in the investing space.