People say bad things when they get short and they knock the stock down!

Sounded like he was complaining, didn’t it? Complaining about … Jim Cramer?

From Confessions of a Street Addict, page 61 of the paperback version, he describes his hedge fund’s activities, circa 1992:

… Or we would get short stocks and talk to the analysts about the negatives. We would work to get upgrades or downgrades because we knew, cynically, that Wall Street was simply a promotion machine.

There are two gripes that always pop up when dealing with books of this type, and that they appear in this review isn’t a sign of any shortcoming in Howard’s work; they’re unavoidable. I have some semantic quibbles and minor points of disagreement, but knowing me, that’s also probably unavoidable.

Quantitative Trading Systems sometimes comes across as an AmiBroker user’s guide. This is the software used to describe the trading algorithms and to test the results, so some level of live examples is to be expected. I suppose that a book like this could be written entirely in pseudo code, but whom would that help? Like it or not, every book on trading systems is held hostage by the software used to test, to whatever extent the book digs into the results.

The book focuses exclusively on technical analysis. I use “technical analysis” in the “old school” sense, meaning that it is confined to data derived from price and volume movement, including indicators build on the same. Unfortunately, these books are difficult to write for fundatechnical or fundamental strategies, for a variety of reasons. Aside from a lack of cheap and broadly available historical data, the historical data is subject to revision, which opens up another can of worms. Indeed, Howard consciously chooses to list reasons for avoiding fundatechnical or fundamental strategies, as opposed to the typical pattern of these books’ avoiding those methods because they’re following the “path of least resistance.” Because of the focus on technical and statistically analyzable strategies, there is a general slant towards systems that trade frequently.

The good news, and there is plenty of it, comes from the completeness and execution of the analysis and presentation. After laying out the five questions of any trading system over several chapters, Howard dives into explanations of the different types of systems. Covered briefly, he includes trend-following, mean-reversion, seasonal, pattern, sector, and rotation systems. He also includes a discussion of portfolios, as well as filters and timing systems.

It should be noted that the author is not trying to provide fish, but is, instead, describing how to fish, starting with selecting the cane to make a pole from. Some of the example systems strike me as “straw men” used to illustrate the principle behind the type of system without providing an actual, working system. The “pattern” chapter comes to mind, here, as many visual chart patterns can be described in code and several simple patterns can be profitably traded, but a single, simple, and non-profitable, example is used by Howard to describe the genre. This is a starting point for designing your own systems, not a book of systems to be bought and used. It also is not a taxonomy of systems inside each category: for that, you have to do your own research.

The remainder of the book fleshes out some other necessities of any well-rounded discussion of quant trading, including a discussion of testing and development. In-sample versus out-of-sample data is discussed, as are statistical tests for validity of the results. Walk-forward and Monte Carlo testing chapters are included.

This is very frankly the best book on trading that I’ve read this year, and one of the best I’ve ever read on the subject of quant trading systems. As a math nerd with an interest in system trading, I’m squarely in the book’s target audience, but if you have interest in the subject but lack the background in math and statistics, I would still strongly urge you to get this book. With time and a little effort, almost anyone can develop enough background knowledge to understand and apply the principles, even if they don’t use the same software used by the author. It all depends on how serious you want to get about this.

I see the book in four parts, even though it really isn’t designed that way, and there’s a lot of chronological overlap between the parts. There’s the autobiographical pre-collegiate portion, the college years (which include a lot of trading), the hedge fund experience, and the epilogue. There’s very little about actual trading technique in the book, and that’s OK, because it didn’t strike me as fitting the purpose or character of the book. The recurring trading themes include the facing of ego, crises of confidence, and the need to change with the market if one’s style is fitted to current conditions. Tim’s very introspective about his own foibles, and that’s admirable.

For me, the book didn’t really hit its stride until the hedge fund section. I had had a vision of the industry as an insular, who do you know and who do you blow “good ol’ boy” network, and Tim’s fundraising efforts gave me a view into that world which both confirmed and deepened my initial impression. It’s not exactly a field where one can simply excel at money management and attract attention and clients, there are networking and selling skills, and “optics” involved. Not that this is per se different than most business fields or than independent consulting, it is just “more so” because it’s the Street.

Tim’s fund had one substantial similarity to the fund of a much more famous manager, Little Miss Goody Two Shoes himself, Jim Cramer. No, Tim didn’t engage in “dialing for dollars” or other nefarious, analyst-influencing tactics like the “Dark Lord” did! The similarity comes from “style drift,” which damaged both funds significantly. In Confessions of a Street Addict, J.J. describes how his unhealthy and illiquidly high concentrations in small-cap regional banks almost brought down his fund, which was primarily a day-trading (and don’t forget “dialing for dollars!”) enterprise. Meanwhile, over a decade later, Tim’s daytrading and short-term plunging fund is damaged by an illiquid “investment” in a single company. I think that’s a bigger lesson than anything else in the book, when managing money, “Shoemaker, stick to thy last!”

Tim spends some time in the epilogue discussing hedge fund regulation, and by and large, I don’t have too many disagreements with his conclusions. A good portion of the regulation appears to be aimed at preserving the “good ‘ol boy” network, no surprise to me.

I enjoyed this peak inside Tim’s head and the hedge fund industy.

Buy “An American Hedge Fund” by Timothy Sykes at Amazon.com

Page 61 of the paperback version, he describes his hedge fund’s activities, circa 1992:

We became merchants of the buzz, getting long stocks and then schmoozing with analysts about what we saw and heard that was positive. Or we would get short stocks and talk to the analysts about the negatives. We would work to get upgrades or downgrades because we knew, cynically, that Wall Street was simply a promotion machine. We recognized that analysts existed to promote stocks, typically the stocks their companies brought public, in order to get those stocks higher.

Further down the page:

… we would load up with call options and common stock and then give the good news to our favorite analysts who liked the stock so they could do their promotion. That would get the buzz going and we would be able to liquidate the positions into the buzz for a handsome profit.

He calls this “dialing for dollars.”

Fast forward ten pages and three years. Cramer has written an article for SmartMoney magazine about several stocks his fund owns, and has carelessly left off the disclosure statement about his ownership. He is concerned about a possible investigation by the SEC, because the small cap stocks he mentioned moved considerably in the time following the article, and his fund had positions exceeding 5% in each of them.

The government doesn’t want people saying nice things about stocks they own without the public knowing that the writer could benefit from the increase in price that the article causes.

Fast forward two more pages, and Cramer is talking about himself.

No one had ever challenged my ethics. I had been the proverbial Boy Scout, never breaking any laws, never even getting a parking ticket. I had nightmares about overdue library books. I was Little Miss Goody Two-shoes.

In the investigation that followed, no evidence was found that he ever used any of the articles written to benefit by selling into the buzz. So he “sold into the buzz” only when the buzzing was telephonic and was directed at Wall Street analysts, and never when writing for public consumption.

I wonder whose money was buying the stocks when an analyst upgraded them, back in 1992, when Jim’s fund distributed information about them after first accumulating a position? I wonder if the people whose money was being used to buy the stocks Jim’s firm was pumping knew that (1) Jim’s firm had a beneficial interest in the securities and (2) Jim’s firm was at least partially responsible for the decision of the analysts?

It’s apparently both “ethical” and “legal” to pump and dump, as long as you’re doing it to analysts for firms that will then have their brokers make phone calls to clients who will then buy and sell based on what you’ve pumped, or the have the firms buy and sell using clients’ money based on what you’ve pumped, or have the public buy or sell based on the analysts’ recommendations. It’s only an unethical, illegal “pump and dump” if you do it directly to the public. If you use intermediaries, and get the same result, it’s something any proverbial Boy Scout would do.

I’m so glad that Jim’s book could clear that up for me.

There’s actually a lot to learn from the book, but unfortunately for Jim, most of what there is to learn is “don’ts” and not “dos.” Cramer manages to make just about every trading mistake I’ve seen critiqued since starting this gig. Lessee, he averages down positions, buys all the way down, takes extra-large bets when he’s “sure” of the odds, and his “crisis in 1998″ was primarily due to overlarge positions in illiquid investments as well as overconcentration in a sector (sound like any other hedge funds you’ve ever heard of?). His wife’s a better trader than he is, but she’s not an egomaniac with a TV show, so you don’t know about her.

My trading takeaways from the book include: don’t catch falling knives, maintain constant risk levels per trade, remember that multiple small bets in one industry is the same as one large bet in that industry, never accumulate illiquid positions unless it’s an “activist investor” trade, and don’t royally piss off your investing partners.

It is an enjoyable book, however, and well worth a read! Buy Jim Cramer’s Confessions of a Street Addict from Amazon.com.