The Secret Key to the Financial Markets
Real World Tales of Famous Investment Advisors, Techniques, and Risk
Elliott Wave * Gann * Spiral Calendar * Nature's Pulse * Hillary Clinton * Larry Williams * The Turtles * LeBeau & Lucas
Elliott Wave Theory
Ralph Nelson Elliott spent the latter half of his life poring over stock charts and eventually became convinced that markets move in predictable waves. He was probably influenced by the Dow Theory of primary and secondary trends, and also by Fibonacci numbers, a sequence of numbers (1,2,3,5,8,13,21, etc.) whose proportions match the golden mean (1.618) often found in nature. The basics of the Elliott Wave principle are that markets are said to move in a pattern of 5 waves up and 3 waves down. The largest wave structure is the "Grand Supercycle", which operates over a 50 year or so time period. Each wave can be subdivided into additional waves of 5 up and 3 down, all the way down to minute by minute charts.Robert Prechter is the man probably most associated with the use of the Elliott Wave principle. Prechter, along with A.J. Frost, published some of R.N. Elliott's works, bringing the work to the public for perhaps the first time since Elliott's day. Prechter made an impressive showing in a 4-month trading championship in 1984, and was a highly rated market timer in the mid-80's. After 1987, he seemed to be increasingly out of sync with the market, and has been calling for the Grand Supercycle top for about 10 years now, despite a strong bull market. In fact, in 1995 Prechter was predicting that the Grand Supercycle bear market (the bear market "we now face", as he put it) would take the Dow down to between 41 and 381.
My (biggest) problem with the theory is that there are so many exceptions to the rules. Double waves, wave extensions, diagonal triangles, flats, failures, retracements, zig zags, irregulars, combinations (are you getting the picture?), you name it. There are simply too many different ways to interpret the wave structure.
Not long after being introduced to the Elliott Wave principle, I saw Frost and Prechter being interviewed, and what amazed me was that these two guys who literally wrote the book on Elliott Wave Theory could not agree on the current wave structure, also known as the "count".
Years later, at an MTA meeting, I met the woman in charge of S&P's at Prechter's service, and I related this story. She admitted that generally everybody who works there has different counts. She tried to minimize this by saying that you just look for times when all the counts say about the same thing. I just don't know. My view of Elliott Wave is that it provides jargon for describing where one thinks we are in the market.
At a trading conference, Alex Elder made it a point to mention that R.N. Elliott died a relatively poor man. Kind of odd that someone who discovered the "key" to the financial markets didn't make a few bucks.
Update: From Hulbert's Financial Digest, November 2003, for the Elliott Wave Theorist (Prechter's newsletter): "The HFD reports a 19.1% annualized loss from the beginning of 1985 through 10/31/03 for a portfolio that went long or short in hypothetical shares of the Wilshire on this letter’s advice for traders, and otherwise earned the T-Bill rate. Buying and holding, in contrast, gained 12.7% annualized." You will notice that Prechter's website does not contain this kind of performance data.
W.D. Gann
Gann was another believer in certain laws governing the movements of markets. He was said to have made many remarkable calls in the commodities markets, and supposedly amassed a 50 million dollar fortune. This would make him a billionaire in today's money, one of the very richest men in the world, and yet no one has heard of him outside of a few traders. Does this sound reasonable?He placed great importance on both price and time, and we can possibly hold him responsible for the idea of a 50% retracement. The problem is that like Elliott, there are so many possible interpretations it becomes a bit silly (regarding the retracements, not just 50%, but 25%, 33%, 67%, 75% and so on). The amount of "magic" numbers associated with his work is staggering, providing a way to fit any possible outcome into the methodology. Gann used ideas from the geometrical to the astrological.
At the same trading conference I mentioned above, Alex Elder also had a few words to say about Gann. Apparently, Elder met with Gann's son, who said that his father had been unable to support his family by trading. That's worth saying again: according to his son, Gann was unable to support his family by trading! Instead, Gann earned his living by writing and selling instructional courses. When Gann died in the 1950's, his estate, including his house, was valued at slightly over $100,000. In today's money, that wouldn't be so bad, but remember this guy was supposed to be a magical trader, not just a successful newsletter writer, and $100,000 ain't $50,000,000. Draw your own conclusions.
The Spiral Calendar
I first heard of Chris Carolan by way of an MTA meeting where he made an amazing call (the April 4, 1994 low in the S&P, a week in advance). Chris Carolan was a floor trader on the Pacific Exchange who investigated the remarkable similarities between the 1929 and 1987 stock market crashes. His work led him to believe that there are fibonacci time relationships with the lunar cycles between major market tops and bottoms.I created a spreadsheet that used a century of data, identified tops, bottoms, a way to look at magnitude and subsequent "turning points" according to his methodology. The end result was that there seemed to be absolutely no correlation with the projected points. In the meantime, Chris made several predictions on Compuserve that proved to be complete non-events, or worse, such as calling for a multi-year top in the stock market in 1994 (this was after the April lows). I also took a number of his newsletters and held onto them until the predicted dates had passed and checked their accuracy. I found a hit rate of about 1 in 20. Chris later posted a statistical analysis of some of his work, which agreed with the 5% hit rate, however it showed that this was a higher hit rate than would be expected by chance. I do applaud Chris for attempting this kind of work, as precious few people in the business have any concern about reality whatsoever.
However, as a skeptic, I would note that the dates Carolan used were a result of his long search into the data and it is reasonable to expect that they may be tainted. It is not particularly surprising that they would show a higher rate than chance. What you really need is out of sample data, and given his long term time frame, I'm not sure it's going to be possible in this lifetime.
It is possible that Chris may be an example of a good trader who succeeds in spite of his "lunacy," however I'm not sure we'll ever know. Like many others of this type, I have never seen any kind of an accounting of his actual trading recommendations, and that, above all, is the kind of thing I want to see before making investment decisions. On a positive note, I will say that the research and scholarship he puts into his newsletter is admirable, and he has an interesting put/call model based on 30 minute data. But it always seems a bit curious to me when people make these grand claims but don't have any performance data, not even hypothetical data. C'mon guys, this is a numbers game, and brokers send you statements.
Nature's Pulse
Nature's Pulse is software developed by Ed Kasanjian, that purports to forecast future turning points in the markets with amazing accuracy. A while back, they would seek publicity by putting a forecast in an advertisement or sending out private mailings. They made a good call for a turning point in the S&P in late March 1994, just before the big drop. The basic idea is the use of fibonacci relationships in time between turning points, although the software can handle fixed cycles as well.I once had access to Nature's Pulse, and spent a good 16 hours or so with it, armed with info from a phone call with Ed Kasanjian himself about how to best use the software. Despite this, I found through careful (and tedious) backtesting that I couldn't pick turning points better than random chance.
I noticed that according to their terminology, almost anything can be called a turning point. If it's a bottom, which are generally more obvious formations, they are allowed to be plus or minus one day. If it's a top, it can be just somewhere in the middle of a broad top. Also, any day (plus or minus one day, of course) that is a big up or down, can be considered correct as a turning point, a so-called "acceleration" day.
In some of their mailings, there were "turning points" identified that were only 3 days apart. If you're talking about plus or minus one day, well, I guess just about every day would qualify. One mailing said there would be turning points in the S&P on 7-26-94, Gold 7-30-94, and Soybeans 7-15-94. Look 'em up and decide for yourself. I suspect you know what I think.
As an interesting postscript, in February 2000 Kasanjian sent out a letter promoting his new pattern recognition software. In a bold move, he promoted his new software by admitting that his previous software didn't work:
My major goal with the new windows version of Nature's Pulse was to include some new automated features. In order to do this I had to do some extensive research to find what worked and what didn't [that would seem like a good starting point, huh?]. All of it was focused on the time/price analysis using sets of ratios to project future turning points and price levels. After a solid 6 months of systematic testing of everything I could think of, I was not able to come up with anything that worked consistently for forecasting future turning points and direction. This was a major disappointment and is why I pulled the plug after spending well into the six figures on the project.
Hillary Clinton turns $1000 into $100,000 in one year
If you talk to a bunch of people who are knowledgeable about the commodities markets, you will find exactly no one who believes the Hillary Clinton story. No one.Bear in mind that the complete records of Hillary's trading have never been revealed. An analysis of the trades that have been made available was completed by a couple of economists for publication in the Journal of Economics and Statistics. They calculated that the probability Hillary's trades were legitimate was less than one in 250,000,000. An IRS attorney commented that the commodity account had "all the trappings of prearranged trades." Additionally, the coverup of the Clinton's 1978 and 1979 tax records conveniently lasted past both the statute of limitations and the timing of Clinton's presidential campaign.
The back story is that Tyson Foods, one of the biggest businesses in Arkansas, was the beneficiary of an enormous number of subsidies during Bill Clinton's soon to come governorship, including nine million dollars in state loans, the allowance of sludge to be dumped into the rivers, and the raising of truck weight limits. A lawyer for Tyson Foods, Jim Blair, introduced Hillary to Robert Lee "Red" Bone, a commodities broker.
At the time the Clintons had very little money, and at the end of it all the commodities profit was used to buy their first house. Hillary began trading cattle futures with $1000, a curious amount as the minimum required exchange margin at the time was $1200, so she shouldn't have even been allowed to trade in the first place. She was allowed to continue trading with a severely undermargined account on numerous occasions. Like on July 12, 1979, when she was allowed to continue trading, yet another customer who was undermargined only half as much had his account liquidated.
Before Hillary had even been introduced to Bone, he had been suspended from trading for a year for manipulating the egg futures market. Later, Bone was suspended for three years for allocating winning trades to favored customers while dumping the losers on others. This is almost certainly what was done in Hillary's account. At one time Hillary claimed that she studied the markets and made the trades herself. Now she has changed her story, saying that Blair and/or Bone were making the trades.
The only, and I mean the only people who seem to think nothing weird was going on are the White House, and a couple of chairmen of the Chicago Mercantile Exchange who were asked for comment. My comment would be that the Merc chairmen, besides wanting to be friends with the White House, have an extraordinarily strong vested interest in having the public believe that commodities trading is both safe and profitable.
Hillary's performance, or even Bone's, if he was legitimately trading the account, would not only equal the highest return ever achieved in a one year trading contest (see Larry Williams below), but would have done so with less risk. How likely do you think it is that Hillary is the best trader who has ever lived?
Larry Williams turns $10,000 into $1 million in one year
Well, probably. There are a few things that imply some cooking of the books, I'm not sure how valid they are. This was a trading contest, and there was this slightly weird thing with the Robbins Trading Company putting Larry on their "team" before he had won. Then there was the fact that Larry's account seemed to be a little mixed up with his clients accounts, and it seems strange that during one 3 month period he made about $1 million in his personal account while his clients lost over $6 million. The National Futures Association had some problems with what was going on and Larry and RTC ended up getting fined $13,000 and $15,000 respectively, little more than a wrist slap. Regardless of any of these allegations, there is no question that Larry's account was actually up over $2 million at one point, which sounds great until you realize he subsequently lost about half of his equity, over a million dollars, in winning the contest. However, in trading contests the incentive is to play fast and loose, so that is par for the course.The thing that sticks in my craw is that Larry has subsequently helped manage two commodities funds that ended up losing more than 50% of their equity and were shut down. I have heard some even riskier tales of individual accounts he managed.
Yet, he did come back years later and made another good return in the contest, and his famous daughter did as well (Michelle, of "Dawson's Creek" fame), using his hotline advice. And I have heard people who have worked with him describe him as a very fair guy. The main point is the risk he took (multiple 50%+ drawdowns over his career) with other people's money.
The Turtles
The guys behind the Turtles are the legends. The "original" big trend followers that racked up huge gains in the 70's. Initially, Richard Dennis achieved tremendous success in the commodities markets, supposedly running a stake of about $1000 into $200 million. Later, along with his partner William Eckhardt, they decided to teach their methods to a small group of people (the "turtles") who went on to have some success on their own. Both Dennis and Eckhardt (and some of the turtles) had some good years, but ultimately ended up running commodities funds that at some point lost half or more of the equity in the fund, and were shut down. However, Dennis and Eckhardt are still in the business, and have done well recently. Ain't nothing wrong with trend following. The main point, again, is to remember there can be a lot of risk involved. If you're down 50%, you have to double your money just to get back to where you were.The Real World - LeBeau & Lucas
These rather extensive quotes are from Computer Analysis of the Futures Markets, a fairly good book on trading, by Charles LeBeau & David Lucas, 1992 Irwin, ISBN 1-55623-468-6
We have seen many examples of traders who have made money by using assumptions of an inherent market orderliness. We have no quarrel with them and will not dispute the fact that many of these traders have been very successful. But we are inclined to attribute their success to good money management techniques and to disciplined risk control, rather than to the validity of their timing theories or forecasting methods.We have never seen it demonstrated that these are anything but the occasional coincidences inevitably occurring when a sufficient number of variables are applied to massive amounts of data. These do not prove the existence of any true cause and effect relationships.
If there were indeed any detailed underlying pattern or structure of prices, the discovery and implementation of that knowledge would quickly destroy the futures marketplace. After all, if the market is somehow orderly and prices are preordained by some unknown controlling force, the trader who breaks this code or determines this orderliness should never experience a losing trade. If anyone "knew" what was going to happen in the future, no one else would trade with this trader.
We have observed that successful traders, those who have been able to profit from waves, cycles, astrology, and other assumptions of inherent order, have been experienced and disciplined enough to wait until the actual price action confirmed that their assumptions were correct. If their actual success was solely dependent on their preliminary assumption or forecast, waiting for the market to confirm that forecast would not be necessary and would, in fact, be quite costly. We have also observed that the entries and exits of these forecasters are often surprisingly similar to our own. The main difference lies in giving credit to a dominant cycle or to a Gann angle that allowed these traders to know something in advance, while our analysis resulted from accurate observations of price activity with no forecasting involved.
As for the occasional accuracy of astrology and other outright forecasts, anyone who makes enough forecasts is destined to be right once in a while. An occasional accurate forecast should not be allowed to validate this methodology, and it proves nothing.
We have seen claims of planetary influence on futures traders, but how could the influence of planets control the futures markets when we know there must always be an equal number of buyers and sellers? ... Shouldn't the alignment of planets influence all of the traders ... ?
So what's it all about?
It always seems odd to me that virtually all "technical" analysts seem to avoid quantifying their results. It seems to me that their compound annual return and their ratio of reward to risk should be the most important criteria for judging their methods. Instead, there is an almost religious atmosphere of belief in techniques that fly in the face of reason. When the results fail to live up to expectations, blame is placed on their own incorrect interpretations of the methods, but never of the methods themselves. I have often thought that if the technicians I have seen at various conferences were required to display a badge with their 10 year compound annual return, there would probably be a lot fewer technicians giving talks, and a lot fewer esoteric methods being touted.I'm not saying it's impossible to find a way to beat the market. Even academics are being forced to admit that there are pockets of inefficiency in the markets. But I think it's important to realize that there isn't any secret underlying structure to the markets, or if there is, no one is saying anything about it. The real key to the markets is that people want there to be a secret underlying structure to the markets, so they find it. People find ways to color their perception of events to fit their beliefs (confirmation bias). People remember their good trades and forget their bad ones. Then they credit their "success" to some bizarre methodology. And, win or lose, people like the excitement that the market provides. People like to brag, talk shop and trade hot tips.
In 1991, I had my first really good year - I made 40%. I made as much in the stock market that year as I did at my day job. I soundly beat the Dow and S&P. But when I looked back on it, I didn't beat the NASDAQ market, and that was where I was investing. Getting pumped up on that kind of "performance" is very easy, but it isn't very realistic. In an up market, investing in the OTC market tends to beat the S&P. Fine. But if you're investing in OTC companies and you don't beat the OTC index, you might as well be indexed.
As for the futures markets, the people that are famous for making actual fortunes in the commodities markets often took on tremendous amounts of risk - their accounts were extremely volatile, and they lucked out on the plus side. There are several market wizards who have subsequently bombed.
To the extent that people are successful over time in the markets, particularly the commodities markets, I think there is a bit more than magic going on. People may attribute their success to some arcane methodology, when actually, as LeBeau & Lucas put it, they have good exit strategies and money management. In some cases, people simply hit a lucky streak and became widely publicized. As in all businesses, a marginal product can be quite successful if marketed well, while a great product will never succeed if the marketing is poor.
But let's face it, the number of people who beat just the plain old stock market on a risk-adjusted basis, over a long period of time, is a fairly small number. The Hulbert Financial Digest is a good source of information for those kind of statistics on newletter writers.