One of the most commonly recommended books to me on the topic of trading systems is Way Of The Turtle by famous turtle trader Curtis Faith. Since this book was the first and most common recommendation from people responding to my Building & Backtesting Trading Systems post, I figured it would be the perfect place to begin my education on system trading.
Faith uses the introduction to give us some general background on commodity trading, Richard Dennis and William Eckhardt, the Turtle Trader Program, and the interview process he went through before joining the program. These where all things I had read about in other books, but the general refresher was helpful. If you haven’t heard of any these topics, Richard Dennis is featured in Jack Schwager’s Market Wizards, William Eckhardt is featured in Jack Schwager’s The New Market Wizards, and the Turtles are the subject of Michael Covel’s The Complete Turtle Trader.
Investors vs. Speculators
Faith begins his first chapter, Risk Junkies, by defining the difference between investors and speculators. He explains that Warren Buffet is an investor because he buys companies that he believes are undervalued and holds them waiting for them to appreciate in value. On the other hand, speculators do not concern themselves with the underlying companies. They trade based solely on price. Broken down further, speculators specialize in trading the risk associated with a given stock or commodity.
Liquidity Risk vs. Price Risk
Faith breaks trading risk into two categories. Liquidity risk is the specialty of market makers and scalpers. They look to make their money quickly from the difference between the bid and the ask prices of a given stock or commodity. Price risk is the risk a speculator takes on when he buys or sells a stock expecting a significant price move.
Scalpers, Speculators, & Hedgers
Aside from some general definitions, the key point that Faith is making in this chapter is that there are multiple different motives and believes employed by different traders all trading the same market. He uses an example where a company is using a market to hedge itself against rising costs of raw materials. At the same time, a speculator is shorting the same market expecting the price to go down, and all the while, the hedger is trading with both of them and taking his cut from the spread.
This is not likely to be new information to anyone reading this website or Faith’s book. The point here is to keep in mind that while we are trading a certain way based on certain beliefs, there are many other people trading many other styles with many different beliefs. There are companies who don’t care if a position goes against them because it is only a hedge. There are traders who don’t have a vested long term interest because they are just scalping for a quick profit. There are even people who don’t know that they don’t know what they are doing.
We must respect what Faith calls the “Collective Perspective” of the market, which is the price at any given time.
This isn’t the helpful nuts and bolts of building a system that I was looking for, but I believe this first chapter is laying the groundwork for a basic understanding of trend following. I expect the book to get much deeper as we proceed through it.