Thinking Outside the Box 5 How to hit home runs: I swing as hard as I can, and I try to swing right through the ball . The harder you grip the bat, the more you can swing it through the ball, and the farther the ball will go. I swing big, with everything I’ve got. I hit big or I miss big. I like to live as big as I can. —Babe Ruth What is striking is that the leading thinkers across varied felds—including horse betting, casino gambling, and investing—all emphasize the same point. We call it the Babe Ruth effect: even though Ruth struck out a lot, he was one of baseball’s greatest hitters. —Michael J. Mauboussin1 Lenny [Dykstra] didn’t let his mind mess him up. Only a psychological freak could approach a 100-mph Since the frst edition of Trend Following, sports analytics has fastball aimed not all that exploded. In the last decade professional sports have undergone a far from his head with total confdence. “Lenny remodeling, with teams scrambling to change strategies to accommodate was so perfectly designed, untold new trends in statistical analysis. There haven’t necessarily been emotionally, to play the major rule changes, nor have there been any substantial changes to the game of baseball. venues or the equipment. Instead, the renaissance is rooted in an uncon- He was able to instantly ventional process k nown as sabermetrics.3 forget any failure and draw strength from every Today, every major professional sports team either has an analyt- success. He had no concept ics department or an analytics expert on staff. The popularity of data of failure.” driven decision mak ing in sports has trick led down to the fans too, Moneyball 2 1 7 7 1 7 8 Thinking Outside the Box as they are consuming more analytical content than ever. There are now entire websites dedicated to the research and analysis of sports statistics, i.e., FiveThirtyEight.com.* The use of analytics has enabled organizations and players to build a more effcient mousetrap, and it will impact every aspect of high school, collegiate, and professional sports.4 From my perspective, the sports analytics revolution also hap- pens to offer an instructive way for traders to digest trend following from an alternate vantage. Sabermetrics might be the best new illustra- tion for bringing people into the study of numbers to the exclusion of fundamentals. Baseball Failure is not fatal, but Baseball has always been a passion of mine. My playing career went failure to change might be. from Little League into college for one year, and I’ve watched more base- John Wooden ball than I care to admit. My childhood friend Kevin Gallaher even made the Houston Astros 4 0 -man roster for a few years in the 1 9 9 0 s. We played and talk ed baseball on almost every team for 1 0 years as k ids, then into high school and during summers while in college. To this day I admire from afar, for example, David Ortiz’s 2 0 1 6 hitting in his last season and at his age (4 0 ): 3 8 homeruns, 4 8 doubles, 1 2 7 runs batted in, and a .3 1 5 batting average. Awesome. I love this game and the numbers that go with it. And I’ve k nown instinctively for some time that baseball and trend following have much in common. But it wasn’t until the revolution, when everyone was ack nowledging the numbers, that the similarities truly hit me. Not sur- prisingly, this was about the time trend follower John W. Henry bought the Boston Red Sox. Henry connects baseball and trend following in Michael Lewis’s Moneyball: “People in both felds [stock mark et and baseball] operate with beliefs and biases. To the extent that you can eliminate both and replace them with data, you gain a clear advantage. Many people think they are smarter than others in the stock mark et and that the mark et itself has no intrinsic intelligence as if it’s inert. Many people think they are smarter than others in baseball and that the game on the feld is simply what they think through their set of images/beliefs. Actual data * Note: More on Nate Silver in Chapter 9 . Trend Following Principles 1 7 9 from the mark et means more than individual perception/belief. The same is true in baseball.”5 And as is evident in trend following performance data, trend follow- ers lik e David Harding, Bill Dunn, and John W. Henry swing for the fence. They hit home runs in performance. If they coached a baseball team they would be Earl Weaver, the former manager of the Baltimore Orioles. He designed his offenses to maximize the chance of a three-run homer. The general complacency of He didn’t bunt, and he had a special taste for guys who got on base and baseball people—even those guys who hit home runs.6 of undoubted intelligence— Ed Seyk ota uses a clever baseball analogy to explain his view of abso- toward mathematical examination of what they lute returns (and home runs): “When you’re up to bat, it doesn’t pay to regard properly and strictly 9 hedge your swing. True for stock s and true for [Barry] Bonds.” Lesson: as their own dish of tea is If you are going to play, play hard. Swing with determination and if you not too astonishing. I would miss, so be it. You will get another swing. be willing to go as far as Babe Ruth, hero of the Yank ees, hero of baseball, and arguably pretending to understand why none of four competent one of the greatest sports legends of all time was k nown for his prolifc and successful executives home runs. However, he had another habit not talk ed about as much: of second-division ball strik ing out. In fact, even with a lifetime batting average of .3 4 2 , he clubs were most reluctant spent a lot of time going back to the dugout out. From a pure num- to employ probabilistic bers perspective, he saw more failure than success. Ruth understood methods of any description the big home runs helped more than the strik eouts hurt. He sum- . but they did not even want to hear about them! marized his philosophy: “Every strik e brings me closer to the next Earnshaw Cook7 home run.” Richard Driehaus, a successful trader who has made millions trad- ing trends, back ed Ruth: “A third paradigm [pushed in the fnancial press] is don’t try to hit home runs—you mak e the most money by hit- ting a lot of singles. I couldn’t disagree more. I believe you can mak e the most money hitting home runs. But, you also need a discipline to avoid strik ing out. That is my sell, discipline. I try to cut my losses and let my winners run.”1 0 But swinging for the fence is often characterized as reck less by the Life is too dynamic to remain static. indoctrinated and or uninitiated. One trading competitor once said John John W. Henry8 W. Henry was Dave Kingman, referring to the ex-ballplayer famous for either hitting home runs or strik ing out. Henry saw talk as unfair: “I’ve been doing this for 2 0 years, and every time there’s a change in the mar- k et, they say I should change my ways. But every time there’s a period when we don’t do well, it’s followed by one in which we do extraordi- narily well.”1 1 Henry’s multi-decade performance was much closer to Babe Ruth’s than Kingman’s. Consider the actual hitting statistics of Ruth and Kingman (see Table 5 .1 ). 1 8 0 Thinking Outside the Box Even before he trained with TABLE 5 .1 : Babe Ruth versus Dave Kingman legend Richard Dennis, Jim DiMaria had learned an Babe Ruth Dave Kingman important trading principle At Bats 8 ,3 9 9 6 ,6 7 7 in the less lucrative arena of baseball statistics: The Hits 2 ,8 7 3 1 ,5 7 5 players who score the Runs 2 ,1 7 4 9 0 1 most runs are home run Home Runs 7 1 4 4 4 2 hitters, not those with consistent batting records. Batting Average .3 4 2 .2 3 6 “It’s the same with trading. Slugging .6 9 0 .4 7 8 Consistency is something to strive for, but it’s not always optimal. Trading Compare the slugging percentages. Kingman could not be consid- is a waiting game. You sit ered a great run producer by any measure. On the other hand, John W. and wait and make a lot Henry’s performance numbers were consistently outsized. He had a great of money all at once. The slugging percentage. Of course, most want the fantasy: big homeruns, but profts tend to come in bunches. The secret is to go zero strik eouts. sideways between the home To further illustrate, consider a modern-day example: blue-collar Joe runs, not lose too much versus the entrepreneur. Blue-collar Joe is paid the same sum every two between them.”1 2 week s lik e clock work . In terms of winning percentage, blue collar Joe is k ing: His ratio of hours work ed to hours paid is one to one, a perfect “What kind of people are 1 0 0 percent.