Thursday, June 27, 2013

Keeping the faith

When using a trend following strategy, it is imperative that you follow your rules. Failure to do so will ensure that you do not achieve the results that the approach would indicate, or that you desire.



This is particularly true when things start to go against you. For example, imagine you are in a long trade. It is possible that the indices may also be going up. Yet, your own position is lagging, or even worse, starting to go in the opposite direction. Do you cut the trade or keep the faith?

In this example, you will find quite often that, when you close the position in disgust, that point marks the exact bottom of the pullback or retracement. Then the stock starts moving back in the anticipated direction. The only difference is, you're no longer in the trade. How frustrating would that be?

You have to look at the trade in its simplest terms. You opened the trade in anticipation of profiting from a trend. Is the trend still valid? If yes, stay in the trade. If no, get out.

Experience has taught me (and many other traders) that, if the trend is still valid, then closing the position is the wrong thing to do. It might save you money on a small percentage of trades, but in the long run you are far better following the rules of the system. Both Ed Seykota and William Eckhardt talk about this in their Market Wizard interviews.

You determined the system rules, which presumably you have tested, or have been proven to work. These tell you when to get in and out of a position. So why would you do something different? If you did, what's the purpose of your rules?

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