Trading Book Reviews

Book Review: The (Mis)Behavior of Markets

[easyazon-link asin=”0465043577″]The (Mis)Behavior of Markets[/easyazon-link]I’ve been reading a pretty interesting book over the last few weeks. It’s [easyazon-link asin=”0465043577″]The (Mis)Behavior of Markets[/easyazon-link], by Benoit Mandelbrot. The author is probably best known for his work with fractals, but has been researching financial markets on and off since the 1960s. I picked up the hard copy edition during a bargain book sale after the holidays using one of the several gift cards I received, and have been reading it on my commute.

First, a warning. This is not a book that’s going to teach you how to predict the markets. If you’re looking for that kind of book, look elsewhere. In fact, if you’re looking to learn about trading or investing in the markets, this is probably not a good book for you. This is not an overly practical book in terms of providing any methods or techniques for use in your day to day trading.

The (Mis)Behavior of Markets is much more along the lines of a scholarly discussion of prices. For those with a desire to understand how prices move, this is a good book. In particular, it’s great for understanding why it is that even the supposedly best and brightest (like Long-Term Capital Management – LTCM) could get it so wrong. In short, much of what university economics and finance departments have been teaching for years is at best misleading and at worst dangerous.

I must state for the record that I have long held a less than agreeable view toward efficient market theory, Black-Scholes, random walk, and all of that stuff. It goes back to my days as an undergraduate finance student when I just intuitively didn’t believe what I was being told and often saw the major flaws. When I started working in the markets I saw first hand how ridiculous many of the underlying assumptions behind classic financial theory really are. In The Essentials of Trading I presented some of the basic ideas, but also indicated what I saw were the major issues.

In The (Mis)Behavior of Markets, Mandebrot takes on classic financial theory in a very straightforward manner. He is extremely critical of the way economic (and by extension financial) theory has been developed and moved forward. He spends a fair amount of time explaining how the now classic theories of price movements came about, which I found interesting since I’m a bit of a history buff.

From what I understand, many of the things that I used to gripe about with my professors as being major flaws in classic finance have finally been recognized in recent years by academia as just that. This from a professor friend of mine. I don’t know whether or not things have changed in what’s being taught, though. My impression is not so much, which to me seems a major disservice.

The thing I found most interesting in the book was how all these theories have been torn apart, not just recently, but for decades. Mandelbrot and others figured out very early on that price changes do not conform to a normal bell shaped distribution. They also figured out that price changes are not independent. Those are two major capstones underlying efficient market and random walk theories and the pricing of options using Black-Scholes.

The thing that really irks me is that none of these critiques were ever presented to me in the classroom. We were just taught the same stuff that had been taught for years and years with no perspective on how research was showing major problems.

The biggest thing Mandelbrot focuses on in terms of the implications of all the erroneous assumptions is the implied risk. He points out that things like the Crash in 1987 should literally never have happened according to classic theory, and that other market shocks in recent years were also so improbable as to be beyond the reasonable expectation of classical theory. Given how many securities are priced using models based on that classical foundation, and how the commonly employed Value at Risk (VAR) calculations are similarly based, you can see how this is a major problem. Investors and institutions have been taking much more risk than they thought. This is something which once again became readily apparent last summer as the credit crises exploded.

Mandlebrot, naturally, presents a different way of looking at price movement – one founded in his fractal theories. He readily admits, however, that it is still early in its development. Much more work and research needs to be done. One cannot use anything he presents in the book to help forecast prices, though it can help to understand better how prices move, and thus by extension the risk of financial assets, which is a benefit of potentially enormous value on its own.

All in all, I would call [easyazon-link asin=”0465043577″]The (Mis)Behavior of Markets[/easyazon-link] a good read. It’s informative and thought provoking, but doesn’t bog the reader down in a great deal of math and complexity (there’s an appendix for those inclined in that direction). If you are at all intellectually curious about the financial markets, this is definitely a book worth reading.

Reader Questions Answered

What does The Essentials of Trading entail?

A gentleman by the name of Jeff asked “What does The Essentials of Trading entail?” in a comment on a post about gold I wrote the other day on my Rhody Trader blog. Since this is the trading education blog and that one just my thoughts on the markets, my trading, and other stuff, it made sense that I should answer the question here rather than there. So here goes.

The History of The Essentials of Trading
The Essentials of Trading book by John FormanI wrote The Essentials of Trading a few years ago when I was partnering with a professor friend of mine on a university summer trading course. We were going into our second year teaching it and I was looking around to see if there was a good general introductory trading book. Try as I might, I couldn’t find one. All the basic books were either market or style specific (swing trading stocks, day trading, forex, etc.), or assumed a familiarity with trading that not everyone has.

I was working with college students who had a basic understanding of what the markets were about, but had pretty much zero exposure to actual trading. Believe it or not, college finance programs don’t really provide students with much that is useful for individual trading. I know. Shocker!

Since I couldn’t find the introductory book I was after, I decided to write one (The Essentials of Trading wasn’t the original title – but I can’t remember anymore what it was). It became a book about trading that didn’t focus on any one market, but rather discussed them all along the way. That’s what I needed for the college students since I couldn’t say ahead of time whether they were going to be stock traders or forex traders or futures traders, or anything else.

I thought things out in terms of a semester long type of structure and included a lot of exercises and practical application elements along the way. Some of it could even be turned into homework and/or exam type things for classroom application. It was really helpful being able to apply the stuff in the classroom as I was developing it. In particular, I found that I should rearrange the way I presented a couple of key things, causing me to shuffle them around in the book.

Taking the New Trader from Nothing to Something
The intention of the book was to take the reader from ground zero – little to no knowledge of the markets and trading – up to the point where they had a sufficient foundation to be able to take on the markets in a reasonable fashion. That meant starting with the very basics of prices and transactions and position monitoring and all the stuff that anyone in the market for a few years takes for granted. Then it was on to explaining how and why prices move and the types of market analysis employed. In the middle third it really gets seriously into trading plan development, with the rest of the book essentially going into the various specific elements of one’s plan – risk management, trading system, etc.

I never intended The Essentials of Trading as a “this is how to make money in the markets” type of book, because any given book of that sort is completely useless for most of its readers. I don’t say that to imply poor book quality. What I’m saying is that those types of books attract people looking for answers to questions they aren’t even able to ask yet.

Instead I focused on helping people understand how they individually should approach trading. Once someone has that kind of foundation they are much better positioned to take the step of reading the book on swing trading stocks or day trading forex or whatever best suits them – rather than running around willy-nilly as most new traders do.

I kind of think of it like a PhD program. In order to get a doctorate the candidate must demonstrate a foundational competency in the subject matter. Then they have to do their doctoral thesis. The Essentials of Trading was meant to be that foundational competency which then allowed the reader to pursue her or his trading thesis.

From Trading Course to Trading Book to Trading Course
The Essentials of Trading basic introductory courseThe book was published in April of 2006 by Wiley. Later in that year I actually kind of turned the process around. I took the book material and taught it in course format again, though online rather than in the classroom. Doing that allowed me to see what it was like in application once more. Along the way I added some supporting materials and some audio discussions with other traders to support a general desktop video presentation.

That collection of materials became The Essentials of Trading Home Study Course. It’s about 9 hours of video lecture material covering everything the book does (and more) and 4 hours of seperate audio discussion with other traders, plus some additional video and e-book materials.

I hope that answers the question.

Trader Resources

New Trading and Investing Education Efforts Coming

A couple of weeks ago I posted a survey of sorts about trading podcasts. Thanks to those of you who provided some thoughts on the subject. It has all been quite useful. This is a project I am working with Corey from to get developed. He put something up on his blog a little after I did, and got some good responses as well. We’re quite excited about pulling this project together.

Corey and I will be talking on Sunday about things, but I think we’re going toward a weekly program of about an hour in length. We’ll likely segment the show into a couple of parts to allow us to talk about current market events and views and broader trading/investing education subjects.

If you have any thoughts or ideas, by all means leave a comment.

The other thing I’m probably going to soon be starting on – as if I don’t have a whole slew of other things on my plate – is a trader FAQ. This would probably be a book concept. I get loads of questions by email and through the site, and I answer others on forum sites all the time. There are several which are repeatedly asked by new traders. It’s about time they all got compiled in one place for easy reference, so that’s what I’m looking to do – probably with some help. It might take me forever to actually get it done otherwise.

Want to help get me started? Let me know what questions you think are the ones most common to new traders? Leave a comment with your thoughts.

Reader Questions Answered

Is the Turtle Trading System a Good One?

I addressed a question on LinkedIn the other day that I thought would be something of interest to folks here as well. The asker inquired:

I am trying to learn more about the ‘Turtle Trading system’ outlined in Micheal Covel’s book. Has anyone have experience with it? Is it easy to learn and follow?

The book to which this gentleman refers is The Complete TurtleTrader. It’s one which I did a review of a while back (Book Review: The Complete TurtleTrader). Actually, I think the Turtle system is presented in a better fashion in Way of the Turtle, the one written by Curtis Faith (Book Review: Way of the Turtle). Covel’s book is a good history, but Faith’s is a more indepth view of the Turtle way of trading.

To answer the basic question, though, while the Turtle system is easy to learn and follow, it is not one most traders can use. It requires a lot of capital to employ properly. In response to that, Gerry (the questioner) asked:

Are there better trading systems out there? Also, does your book go into the steps of setting up a trading system for a small investor?

My response to that is better, of course, is a relative judgement. What is great for me might be awful for you. What may work well for large portfolios, may work poorly for small ones, and vice versa. If you don’t have the capital to trade the Turtle system as designed, then yes, there are better ones for you out there.

As for my book (The Essentials of Trading), it does indeed talk about trading systems. There are three chapters talking about developing, testing, and comparing them.

Trading Book Reviews

Book Review: How I Made $2,000,000 In The Stock Market

[easyazon-link asin=”9562914534″][/easyazon-link]This week the book I read during my commute was [easyazon-link asin=”9562914534″]How I Made $2,000,000 In The Stock Market[/easyazon-link], by Nicolas Darvas. It’s a trading text I’ve been aware of some time, primarily through the discussions of and recommendations by others, but I’d never gotten around to reading it myself. After Christmas I took advantage of some gift cards and discount sales to pick up a copy so I could give it a read and provide a review.

First, be aware that this book – at least in the version I have – is quite short. It’s only a bit over 100 pages, and a healthy portion of that is editorial addition tagged on to help further explain the author’s story, along with some Q&A with Darvas tossed in. You should easily be able to get through it in one sitting.

Second, this book – again, at least the edition I have read – was very poorly copy edited. There are formatting issues all over the place. It’s not necessarily the easiest book in the world to read to start with, as the author’s narrative leaves something to be desired. The formatting issues, don’t help make for a particularly enjoyable reading experience.

Thirdly, you will note that I have used “story” and “narrative” in describing the text. That’s exactly what it is. Nicolas Darvas was a professional dancer who performed all around the world. The book describes how he somewhat randomly got into the stock market, and then the progression he made to building a $2 million portfolio for himself. All of it takes place during the 1950s, so be prepared for the author to talk about cables and things that modern readers will have little to no point of reference on.

At it’s core, How I Made $2,000,000 In The Stock Market is a trading diary of sorts. The bulk of the book is a discussion of the various trades the author made over about a 6 year time frame. Some readers will find that interesting, others will yawn. But that’s not what you read this book for, fortunately.

It is the developmental path Darvas takes from newbie to multimillion dollar trader – which the author interweaves with the discussion of trades - that is the read value to be had from How I Made $2,000,000 In The Stock Market. Anyone who has gone through that developmental process as a market participant will immediately be able to relate, and those who haven’t yet (or are just starting to do so) will see that even wildly successful traders went through their struggles.

In parallel with the author’s discussion of his personal trading development is also the construction and refinement of his trading strategy. As is the case with most traders, he started on one path, but shifted course several times until he finally found the methodology which suited him best.

Darvas employed a combined fundamental and technical approach which is the core of the popular CANSLIM methodology outlined in How to Make Money in Stocks. It’s not an exact thing in terms of application, as Darvas developed an entry/exit strategy based on what he called boxes, but a great deal of the preliminary set-up elements are very, very close. That philosophy is definitely something that works. I can personally attest to it myself, though I have never employed Darvas Boxes or anything like that.

The issue a reader might have, though, is that the outlining of this methodology isn’t concisely presented. Rather, it’s spread out over the course of the narrative, presented in bits and pieces over the timeline as Darvas refined his approach to trading. It would probably take a couple of readings to really get a handle on things.

Overall, I definitely think there’s value to be had in [easyazon-link asin=”9562914534″]How I Made $2,000,000 In The Stock Market[/easyazon-link]. If nothing else, it proves that part-time trading can be extremely rewarding. As I commented above, it’s not a great read as books go, but there are quite a few good nuggets in the text if you can fight through.

Darvas must have enjoyed the notoriety he developed because he authored a couple of other books as well. If it get the opportunity, I might give them a read down the road.

[easyazon-image-link asin=”9562916006″ alt=”Darvas System for Over the Counter Profits” src=”” align=”none” width=”107″ height=”160″] [easyazon-image-link asin=”0818403985″ alt=”Wall Street The Other Las Vegas” src=”” align=”none” width=”107″ height=”160″]

Trading Book Reviews

Book Review: American Sucker

[easyazon-link asin=”031615928X”][/easyazon-link]Over the last few weeks the book I have been reading during my daily commute was [easyazon-link asin=”031615928X”]American Sucker[/easyazon-link] by David Denby. Basically, this is an autobiographical look at the experience of an individual stock investor/trader during the period of roughly 1999 to 2002. That, of course, was very challenging time for participants in the equity markets and it is clearly documented in the text.

Before I get into talking about the story, though, it’s worth taking some time to consider the author. Denby is a writer used to addressing a fairly sophisticated audience. His primary vocation was as film critic for the New Yorker and he had previously authored a book discussing the classics thinking of Western civilization. As such, his language is not that of one writing for the masses. I consider myself pretty well read and with a decent vocabulary, but there were several words Denby used in American Sucker I’d never heard before.

That said, I didn’t find the book to be pretentious or anything like that. From a writing style perspective it was a pretty smooth read.

Getting to the subject matter, I found it a really interesting perspective on the thought process of the individual investor during a time span which ran from euphoria over the prospects of profits from a market rising rapidly to the depths of despair in the face of not just falling prices, but also destroyed confidence in the whole system. As such, Denby caught the tone of that whole period of time during which the stock market peaked and then fell in the most dramatic of fashions. In fact, I couldn’t help but draw comparisons to what’s going on in the markets and the economy right now.

I think the first real benefit of reading this book for someone involved in the markets is the psychology of investing which plays out in the author’s thinking and actions. He starts off not wanting to miss out, wanting to get his fair share out of the booming stock market of the late 1990s. The euphoria of the time combined with personal developments in his life to lead to toss all his usual caution to the wind and jump into things with both feet. Later, as the markets start to unravel and his portfolio value is dramatically reduced, Denby talks through the waves of hope and fear that are so often found in times of strain.

Basically, anything you have ever read about in trading psychology texts regarding the way most people’s mental process works while watching their account values rise and fall are clearly seen through Denby. It’s all there. As a reader, you can actually see the thoughts and actions which create the price patterns so prevalent in bear markets.

Along the way, Denby documents his evolving beliefs as events in the markets and the performance of his portfolio combine with events in his life. There’s an important lesson to be had there. Your trading and investing cannot be entirely separated from the rest of your life. They are inter-related and that’s something you need to realize can impact on what you do and how you perceive things.

What makes the book even more interesting is the author’s relationship with some of the major controversial figures of the time period. One of them was Henry Blodget, the disgraced Merrill Lynch technology analyst. Another was Sam Waksal of ImClone. Denby’s interaction with both men feature prominently.

Overall, I found [easyazon-link asin=”031615928X”]American Sucker[/easyazon-link] a very good read. Denby does spend quite a bit of time ruminating on the subject of greed and related topics, as well as some other philosophical ideas – his own and that of others. Some readers might find this stuff uninteresting and I will admit that at certain points I skimmed along when the narrative stopped and the deep thinking started. It’s an autobiography by a well read, sophisticated, and mature individual, though. You can’t expect it to be without introspection.

In short, I definitely recommend this book for traders and investors and for anyone else with an interest in the markets.

Trading Book Reviews

Book Review: The Age of Fallibility by George Soros

[easyazon-link asin=”B000PFUCS0″][/easyazon-link]I just got finishing George Soros’ latest book, [easyazon-link asin=”B000PFUCS0″]The Age of Fallibility: Consequences of the War on Terror[/easyazon-link]. Thanks to my brother for the holiday gift. It’s been my commute reading on the subway to work for the last couple of weeks, and I’ve found it quite enjoyable in that regard – making the trip go by a little bit more quickly (not that I have a terribly long ride, mind you).

First of all, it must be said right off that this is not a book about trading. Soros is most famous in the financial markets for his managing of the Quantum Fund and making a billion shorting the Pound in the 90s when the currency broke from the Exchange Rate Mechanism (ERM) which was in place then as a precursor to the eventual Euro introduction. While he does mention events like this and others for which he is famous – or notorious, depending on your viewpoint – neither trading nor the markets are the focus of this book.

The Age of Fallibility is at its core as much a philosophical treatise as an exploration of global affairs. Soros has a pretty well developed world view and philosophy. His ‘reflexivity’ approach to events (markets and otherwise) has been expressed in his earlier books, and is further refined in this one. That is the part of the book which will appeal to traders and investors, as it helps to explain how he looks at the larger movement of markets and how predictable patterns of behavior can be seen. For those who like to take a big picture view of things, it is definitely something worth reading.

As for the remainder of the book, that is a combination of explaining open society, exploring global politics, and attacking America’s foreign policy, as the title would imply (though no major global player is left out of the discussion or immune from criticism). If you are an open-minded sort then you will find Soros’ views very interesting. In particular, I found his discussion on the concept of the “war on terror” very interesting.

No matter what you think of Soros or his politics (and many folks rightly or wrongly have a negative view of him), the fact of the matter is the man has a perspective on things few can offer based on his experience operating his various organizations. As such he is definitely someone to whom we should at least listen. If you can do that, I guarantee he’ll have you thinking at several points in the text. If not, then this may not be a book you’ll want to read.

I personally started the book wondering if the arrogance I found in his earlier market focused books would be apparent in this one too, but I found it wasn’t. The style was very engaging throughout and what he had to say thought provoking. If that’s what you look for in a current events type of book, then you will like this one, all the more for the fact that though the book was written in 2006, it has enough of a macro scope to it to make the subject matter still quite meaningful now in 2008.