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Billy Beane and Trend Following. What Do The Oakland A’s Know?

Approaching the world logically with great discipline is not only the world of trend followers. The following excerpts are from a New Yorker article by James Surowiecki:

Even if you set aside the accounting scams and the free palaces for C.E.O.s, these last few years would rate as some of the most dismal in the annals of corporate leadership. Intoxicated by cheap money, executives squandered hundreds of billions of dollars on doomed mergers, vacant dot-com warehouses, and thousands of miles of useless fibre-optic cable. Now their rickety empires are falling to pieces.

Billy Beane followed a different path. Beane was frugal, Beane was shrewd. In three short years, he turned a stumbling outfit into a profitable enterprise that is the pride of its industry. If he hasn’t been recognized as one of the most successful executives in America, it’s only because his business isn’t derivatives or microchips. It’s baseball.

TurtleTrader® comment: Shrewd and frugal are words that could easily describe Jerry Parker or Bill Dunn. We recently heard from an over-excited European day trader who described trend following as too boring. He said they were like long-haul truckers, but he only wanted to drive a Porsche. Ask yourself, what is your goal? Do you want to make money or drive fast? It is a choice. Everybody gets what they want.

Beane is the general manager of the Oakland A’s, one of baseball’s much pitied small-market teams. The A’s don’t have a deep-pocketed owner or a fancy stadium, so their payroll is small—about one-third that of the Yankees. In an era of high-priced free agents, the A’s should be sad-sack losers, but they’ve reached the playoffs in the last two years, and they’ve been this summer’s hottest major-league team.

How has Beane done it? Most baseball men subscribe to familiar truisms about talent, character, and the chemistry of winning teams. Over the years, however, extensive scientific research into baseball statistics—often called sabermetrics, after the Society for American Baseball Research—has proved most of these truisms to be false. The Copernicus of this revolution was a mechanical engineer named Earnshaw Cook, who, in the early nineteen-sixties, compiled reams of data that overturned baseball’s conventional wisdom, and then presented the data to executives at a handful of struggling teams. The executives shooed him away. So Cook wrote a book, called Percentage Baseball. Most of its assertions were irrefutable.

TurtleTrader® comment: A strategy rooted in numbers is a trend following cousin.

Since then, thanks in large part to the work of the sabermetrician Bill James, a number of baseball executives—including Beane’s mentor and predecessor, Sandy Alderson—have tinkered with the sabermetric method. But Beane is the first G.M. to build his organization around it. He and his assistants focus on things that can be measured (like someone’s ability to get on base), instead of things that can’t (like whether someone is a clutch hitter). Beane uses actuarial analysis to figure out, say, the odds of a high-school pitcher’s becoming a major leaguer. And, in drafting and acquiring talent, he relies on sabermetric truths. For instance, if your team draws a lot of walks and hits a lot of home runs while giving up few of each, it will win a lot of ballgames. So Beane has stocked his team with sluggers who take walks, and control pitchers who rarely give up home runs. This strategy wins games and, equally important, saves money, because even though the players Beane likes are as productive as many high-profile stars with gaudy stats, they come a lot cheaper. Think of Beane as the Warren Buffett of baseball.

TurtleTrader® comment: Thinking in terms of odds is one of the traits of Trend Followers. Not many really look at the world that way. We would compare Beane to John W. Henry, not Buffett.

The A’s approach was born, in part, of necessity. We can’t do things the way everyone else does, because of our payroll, Beane said. We had to create our own niche and be disciplined about staying with it. In a sense, the small budget has worked to Oakland’s advantage. If corporate America’s excesses in the last decade demonstrated the perils of having too much capital, Oakland’s success has demonstrated the virtue of having just enough.

TurtleTrader® comment: Most of the great trend followers started small. They grew slowly. They are not at all like Goldman Sachs or Morgan Stanley. They are independent. They are renegades. Their nature and strategy are polar opposites of the Wall Street world grounded in commissions. Trend followers, just like Beane, realize too much capital doesn’t guarantee a damn thing. Strategy and smarts beats capital 9 times out of 10.

But can it last? In baseball, conventional wisdom may still rule, but Oakland, like any successful business, has begun to attract imitators, which will presumably make it harder for Beane to find his diamonds in the rough. Even so, Oakland has one great competitive advantage: the entire organization has been built, from the bottom up, around Beane’s ideas. In this respect, Oakland resembles companies like Dell Computer and Southwest Airlines, which have structured their business around a coherent strategy. Dell’s rivals have tried for years to emulate its made-to-order, just-in-time model. But the copycats, because their businesses were initially built around different models, couldn’t compete. The major airlines haven’t had any better luck trying to copy Southwest.

TurtleTrader® comment: A relevant question from a reader and our response:

It is truly amazing how traders were so successful using trend following. But that was then. What makes you think trend following still works? Is the fact that too many traders should be using it by now, take the edge away. What I mean is that, any system that is followed by many traders becomes less and less efficient until there is no abnormal return from it. Can you comment on this?

TurtleTrader® comment: You have read our entire site? Where is the evidence trend following has stopped? Start here to change your view. Just like those that think Beane’s success will soon fail, we hear from those that mistakenly believe trend following will soon fail. Whether, baseball or trend following, the naysayers will have a long wait.

Oakland’s success is the fruit of what the legendary corporate theorist Michael Porter likes to call strategic fit. Every part of its business is tightly linked with every other part, creating, in Porter’s words, a chain that is as strong as its strongest link. You get strategic fit only when you have a clear sense of what you are and of what you are not. The essence of strategy is choosing what not to do, Porter says. By choice and by necessity, Beane decided that the A’s would never be a team of conventional stars. And that has made him the best general manager in baseball.

TurtleTrader® comment: What’s our point? It’s obvious. Discipline, discipline and more discipline are the keys to trend following success. You want Holy Grails, not hard work? You are doomed.

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