Sunday, June 17, 2012

A few home truths

Just to clarify a few things about trend following:
  • Trend following historically has a relatively low win percentage, across all asset classes. The positive expectancy from using such a system comes from the size of the winners far exceeding any losses incurred;
  • Trend followers never try to predict tops or bottoms in markets - they buy on strength and sell on weakness;
  • Strict risk managment and position size minimises the losses as far as possible when a losing streak hits;
  • Probably 80% of your trades each year will cancel each other out - consisting of small winners, small losers (restricted to 1R of your capital) and break-even trades;
  • The remaining 20% of your trades will probably account for 100% of your profits, but you never know which ones will generate the profits when you open the position;
  • To achieve this you HAVE to let the profits run until you receive an exit signal;
  • Stops are updated as often as your system rules determine;
  • And you have to adhere to your stops at all times;
  • Nobody knows when a trend will reverse, however when it does, you automatically give back a portion of your profits before your (trailing) stops are hit;
  • If a trend breakout reverses or fails just after entering a position, you will incur losses;
  • Significant increases in volatility can cause losses due to whipsawing or trading 'noise';
  • The best market conditions for trend followers are trending, stable markets;
  • The worst market conditions for trend followers are non-trending, volatile markets;
  • There are numerous trend following methods out there, but although the entry/exit parameters may vary, trend followers as a rule will make (or lose) money in the same markets at the same times;
  • Remember that you need a trend to make money! Simple, but obvious. Periods such as 2011 in general or February/March 2012, where there are no trends, are difficult for trend followers and drawdowns occur in these periods;
  • On the flip side, the downtrends in 2008 and the uptrends in 2009-10 generated huge profits for trend followers, but if you can't accept the above points, then it is highly unlikely you would have profited as much as you should have from these 'trendier' periods in the market.
If you don't understand any of the above points, or are not prepared to accept these facts, then you do not have the mindset to follow a trend following method.

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