Trader’s Narrative

Going back to the end of November 2007, the bond market was giving a great signal that a rally in the equity markets was about to unfold. From the time I wrote about it to its top in December 2007, the S&P 500 Index gained 100 points (1410 to 1510). That may not seem like much in today’s topsy turvy market. But you have to remember that back then the VIX was at ~20.

The idea is that the rate of change in the bond market has a bearing on the equity market. I first read about this in Mark Boucher’s book, The Hedge Fund Edge where he outlines dozens of similar ideas.

Put simply you buy when the rate of change in the 30 year bond yield is less than or equal to 9% and sell when it is above that level. The performance for this simply system is impressive. Equally impressive is that doing the opposite isn’t profitable. This is a sign that we aren’t data mining but dealing with an inherent relationship in the financial markets.

I use a variation of this system, however, the most recent signal didn’t work and I suspect it had to do with the craziness that we’ve seen in all financial markets:

As I briefly mentioned about two weeks ago, there are two books coming out within a short period of time dedicated to the legendary ‘Turtles’. This weekend, I devoured the only one worth reading: Curtis Faith’s ‘Way of the Turtle’. My verdict? No serious student of the markets will miss this book.

The foreword of the book is written by Van K. Tharp and I was surprised to learn that Tharp himself was a finalist in the original Turtle ‘batch’. He never made it since he was more interested in the psychological aspects and in coaching traders, rather than being one himself.

Curtis starts the book by featuring his first trade as a turtle, a long trade in heating oil which won him not only praise from Richard Dennis but double the portfolio allocation of any other freshly hatched turtle ($2 million).

Although Curtis does go into some detail about the process of being interviewed and selected into the Turtles’ program, he moves quickly into new and exciting material. Way of the Turtle is tailored to those who are interested in learning about trading and the turtle trading methodology and not so much about the ‘inside scoop’ or drama of the turtles history, application and interview process, etc. Curtis succinctly summarizes the four elements all great traders possess:

• Trade with an edge
• Manage risk
• Be consistent
• Keep it simple

I found it reaffirming to find Curtis talking about the concept of R so matter of factly - which is a tribute to Tharp since ‘R’ has become an integral part of trading culture within only a few years after its introduction. But more interesting was Curtis’ introduction of a similar concept he calls ‘E’ or ‘E-ratio’. This refers to the effectiveness of entry into a trade, just as R refers to the result of a trade - measured by unit of risk.

In order to calculate it, you need two components: maximum favorable excursion (MFE) and maximum adverse excursion (MAE). You standardize them using the relevant ATR and then divide MFE by MAE. That gives you the ‘E-ratio’. This is an important number because it tells you whether your entry into trades has an ‘edge’. Think about it, if after entering a trade, usually the trade takes off towards the direction you want, with a small or almost nil adverse excursion, you know you’re on to something!

This is just one of the many gems contained in ‘Way of the Turtle’. It is a veritable treasurer trove for both systematic and discretionary traders. Equally impressive is the generous attention Curtis pays to the role of psychology and its effects on trading. All in all, this book is destined to become a classic.

Also don’t forget to check out Curtis’ blog