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The Trend is Your Friend Except When It Ends

My introduction to investing began in college, when my father set up an E-trade brokerage account for each of my siblings and me, with a small gift of Cray Supercomputer stock. I was studying for an Aeronautical Science degree and wasn't sure how to manage the account, so I asked my dad what I should do.

"Do whatever you want with it," he said. I had no idea where to start, so I picked up a book called Market Wizards, by Jack Schlager. And so, a career of learning about investing was born.

Reading the book on my bunkbed in my dorm, I was amazed to read about people who started their lives in a variety of circumstances ranging from dirt poor to aristocrat, but ended up finding huge successes in the markets, which rewards those who 'win' with more capital to trade towards even bigger success.

Granted, it wasn't always successes. Some of the traders not only made fortunes, but lost them, only to make them back again. The author of the book made some conjectures as to why certain people were able to beat the market, which he attributed to innate skill. However, at Golden Goose Guide we know better than that - in order to have wild success at anything you must be a Revolutionary Pioneer in a parabolic market.

One of the Revolutionary Pioneers interviewed in the book was Ed Seykota, who graduated from MIT and built one of the first computer programs aimed at using systematic trend-following rules to beat the commodities markets on a mainframe computer.

His first job at a Wall Street broker was notable in that he wasn't allowed to even use their computer, which were only considered accounting tools at the time. He snuck in over the weekend to test trend-following trading rules, which he later used to great success. He influenced and trained an entire generation of traders, who spread his teachings so far they became common knowledge and no longer usable to beat the markets.

They found their greatest success during the wild 1970s, when parabolic commodity markets, leverage, and a lack of computer trading permitted Ed's followers to make a killing before the computerization of markets rapidly squeezed inefficiencies out.

It's worth pointing out, however, that all of the Market Wizards were ambitious, smart, highly proficient at math, disciplined, risk-averse, and thoughtful in their approaches to trading. While they benefited from impeccable timing, the markets were a cruel master, tolerating few mistakes without consequences.

After graduating college and working as a reserve pilot, with lots of downtime in crew rooms and crashpads, I decided to make my own computer trading program, but for the foreign currency (FX) markets. Forex trading was all the rage then, like today's crypto. People in automated trading forums online all spoke of their search for the Holy Grail.

The Knight of the Holy Grail, by Frederick Waugh. I was going to include a clip of Monty Python here, but it's still under copyright protection.

After testing all combinations of market indicators, like moving averages, I found that many of them worked incredibly well if you back-tested (i.e., testing on historical data) during the 1970s, when markets smoothly trended prior to computers. Suddenly, when you reach the 1980s, computerized, choppy markets become prevalent and no system based on a published indicator worked consistently. This is where the "random walk" model of markets seems to appear for those who depend on technical trading models.

One program, which traded on volatility and used Bollinger Bands to determine whether to set stops at either side of the market, seemed to have a slow, but steady profit in back-testing. However, I went "live" and woke up one morning, to my horror, that a bug in my code caused the program to trade repeatedly against the market, when it was supposed to only trade once per 24-hour period. Back testing and paper trading is no substitute for the actual, live market.

The reality is that there is no way I'd have succeeded at indicator-based computer trading in a market that computerized these tools decades ago. The next revolution was in emerging technologies around data and machine learning, which were employed by sophisticated hedge funds (most notably RenTec) with PhD computer scientists and huge amounts of computing power. If you can understand the rise of Google in mastering data and machine learning in the realm of web searching, you can understand the parallel success with RenTec as a quantitative hedge fund.

It was around this time that I had discovered Warren Buffett and his distinctions between speculating, which he viewed as akin to gambling, and investing, which he considered a bargain purchase of a value creating asset. His philosophy-oriented approach made a lot more sense to me than the chartists and "I go with my gut" types in Market Wizards.

Now, it's unusual to find dedicated FX hedge funds who are willing to take an active risk on such a "random walk" market. That says to me that the only tools worth using for trading systems today, are tools that nobody else is using. Everything else is a fruitless quest for the Holy Grail.

What have we learned?

  1. Look for emerging trends in new technologies that give you an edge

  2. Stay on trend, until the fundamentals change and the trend nears its end

  3. Be prepared to pivot to new trends as competitors enter your space

  4. As competition increases, production costs to keep up go up

  5. The only Holy Grail is timing ownership in the beginning stanges of a parabolic market

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-Golden Goose Guy

Next Article #22: Coming soon!


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