Book Review: Contrarian Ripple Trading
So, what is contrarian ripple trading? Is it a day trading strategy? Is it a volatility trading strategy? In fact, it is none of these things. Despite its edgy and mysterious name, it is actually a sort of hybrid trading/investing strategy designed for the at-home investor by a couple with no real financial background. Martha Brozyna is a medieval history Ph.D. who trades at home for herself and other family members. Aidan McNamara is a graduate in political science who has worked in international banking, but has spent the last 11 years working in financial publishing. They claim that this background makes them uniquely qualified to teach the at-home investor who is likely just looking to earn some extra money and doesn’t want to be overly involved with their stock portfolios.
The strategy they present (which they seem to have gone to great lengths to hide on their website so I won’t go into too much detail) is, in fact, magnificently simple. It’s contrarian in that it expects the follower to purchase only down trodden stocks. And, “rides the ripples” by purchasing and selling only while the stock stays at depressed levels. They sell only when they lock in a nominal profit net of commissions. Hence, why they only claim never having lost money on a roundtrip trade. In addition to these basic principles, the authors purchase only stocks of large cap companies or companies that they themselves feel a unique understanding of.
Unfortunately, the authors’ inexperience and lack of understanding of the fundamental and technical underpinnings of their strategy is readily apparent throughout the book and to some degree detracts from the impact of their very successful strategy. Ultimately, I find that the book is probably not suited for the novice investors that it targets as the authors, probably unintentionally, are somewhat misleading and oversimplify their strategy. Let me explain why.
First and foremost, the buy strategy presented lacks depth and boils down to buy big companies which are trading at 52-week lows when the market is down. I take this to mean when it is in a trading range near its lows for the year and not in the middle of a slide to new lows, but the average reader may not know this. Furthermore, while I appreciate the attempt to be contrarian even to the point of a purchase by telling the reader to buy on a day both the target stock and the market (DJIA) falls, it isn’t necessary for their strategy and is likely dangerous. Basically, they tell the reader to catch a falling knife especially if the reader has misinterpreted and doesn’t wait for their target stock to reach a trading range/base.
Secondly, they present their trading record without any information on total invested capital or the percentage return. This leads to a rather fuzzy picture of just how succesful they were. In fact, some losing positions are held for over 2 years and a back of the envelope analysis of the positions held at the end of their trading record leads one to believe that the strategy requires in excess of $250,000 to be invested at any given time as a result of having to hold some losing positions for long periods of time but still having to make new investments to continue generating nominal returns. Keeping in mind that the authors chose the very bullish years between 2005 and 2007 to report their earnings, the $30-40,000 in realized profit made each year (~15%) is a lot less compelling and even more so when one weighs the risk of keeping $5000 to $10,000 in unrealized losses in their portfolio. In fact, with their rather laissez faire attitude towards holding losers and a suspect buy strategy, I’m surprised the portfolio didn’t include much larger unrealized loses.
The authors would probably counter my above complaint by saying that their strategy is designed to help you make regular nominal profits through stock trading and is not for those looking to invest their money for capital preservation or dividend income. I still believe that the merits of any strategy cannot be properly measured with nominal returns especially without any disclosure of how much money is actually invested at any one time. Let me give an example. I have a strategy which will yield $50,000 every year! This is more than people in the US make per year. They should all quit their jobs and use my strategy. It’s simple. Just take $1,000,000 and invest it in a CD for 5% annual interest.
Third, I have some issues with the authors’ attempts to connect themselves to established traders and investors or established investment theories despite the fact that their strategy does not conform to them. Most glaringly, they spent a lengthy chapter describing Dow theory and using the analogy of the markets moving in ripples, waves, and tides. Unfortunately, Dow Theorists believe that ripples were random ought to be ignored. They mention this, but provide no explanation as to why they feel it is okay that they’ve devised their strategy in direct opposition to the Dow Theory they are trying to connect themselves to. Furthermore, they provide no further technical reasoning for why their strategy should work despite the fact that this trading strategy seems dependent on the very technical phenomena of “ripples” in a stock chart.
Finally, the authors devote much of their book to breaking down some of their best trades and it is here where the book completely loses focus. The authors provide their logic and reasoning for each of their trading positions yet it is obvious that their investment ideas are based on long-term, macro ideas behind a company and its business. There’s nothing wrong with this, but their reasoning is not necessarily a sound way to establish a trading position in a particular stock. Good companies alone do not a good stock make. For example, I could identify Boeing’s stock as being a good buy because it has fallen to 52-week lows but in the long-run I know that Boeing has a brand clout in an industry with relatively high barriers to entry (not everyone has the capital or expertise to make planes) so I decide to buy. This is not the same as identifying that these 52-week lows are as far as the stock will fall or that the stock will rebound anytime in the near future and this is what is necessary when attempting to make a trading decision to make short term profits.
Ultimately, I believe the authors of this book might actually have served themselves better simply being contrarian investors. I give them much credit for having well-formed investment theses behind their stock picks and their insights into the companies that they invested in probably could have made them much more money if they had held their positions longer rather than sell them whenever a minimal nominal gain was reached. I suspect that their trading strategy (particularly the way they have employed it) would not have worked quite so well in the bear market environment we have faced at the end of 2007 and beginning of 2008 where falling markets do not quickly bottom and rebound, but instead seem to just keep making lower lows. Without an unlimited bankroll, the consistent generation of realized profits that this strategy boasts does not likely hold up.
So, is Contrarian Ripple Trading without merit? I don’t believe so, but it could have been better written. The way the authors present their strategy and trading habits minimizes their strategy into basically a Dow Underdogs strategy coupled to a hyper-conservative sell strategy. The implications of their strategy, however, are a lot more interesting and could have been presented as such. On a strictly technical basis, they seem to have found a method of trading which allows them to capitalize on the volatility exhibited by a stock during a basing period. Their success in over 1000 round trip trades (even during a bull cycle) deserves to be commended and, with a little further analysis and research, they could have a real winning trading strategy on their hands. In fact, in the coming days, I will publish my own post proposing my take on “contrarian ripple trading” which might work well as an addendum to their book especially for more seasoned market technicians.
If you enjoyed this post, please consider to leave a comment or subscribe to the feed and get future articles delivered to your feed reader.
