Trader’s Narrative

Speaking of turtle trading (Way of the Turtle book review) and trend following, anyone noticed that the Mexican stock exchange has been on fire for the past few years? The chart looks beautiful with a gradual angle of ascent and very orderly pullbacks to support (200 day moving average):

If you look at a very long term chart (20+ years) you will see that this trend built a solid base from which to take off. The Mexican markets reached a peak in early 1994 and didn’t revisit that level until 2004! After basing just under the resistance level (~11,000) for a few months, they broke out in late 2004. And never looked back.

Until last year, Brazil (EWZ) was the strongest Latin market. Then it faltered and was overtaken by Mexico. Also notice how the relative strength of the Mexican market was extremely strong against the S&P 500. Even after each pullback the trendline of the relative strength was not broken. They were merely dips within a march upward.

So, is it too late to jump in? Well, considering that the base was 10 years in the making, a measured move would also last approximately 10 years. We’re in the 3rd year, so we have quite a ways to go yet. That being said, I wouldn’t just jump in headfirst. Wait for a pullback, especially to support levels or to a long term moving average (or sweeter still, the conjunction of both).

And if you’re a short term trader, put it up on your watchlist. It is almost in ‘free air’ territory again (meaning that every long is happy). We could have a breakout and long range day today if it breaks out of the mid-February resistance level.

Another way to play this is to not use the ETF (EWW) but to drill down to the components and find the strongest individual stocks and play those on the long side. The advantage is that you’ll get more beta for your bucks, but you’ll probably be stepping in much less liquid securities.

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