Saturday, June 23, 2012

Trend followers like to be different

Trend following is frequently seen as a stodgy, out-of-date trading methodology compared to new fangled high frequency trading, day trading and other strategies either involving complex formulae, or loads of indicators and squiggly lines drawn over charts.

The true beauty of trend following is in its simplicity. The system rules are relatively straightforward, and can be condensed down to a few simple one liners. Anyone can learn a trend following method, but many refuse to believe that such a simple strategy can make money, and lots of it.

Lots of traders also believe that there is a 'holy grail' out there, and think if they incorporate lots of rules and complex set ups into their own strategy, they will be successful. To a trend follower, trading is extremely simple, but the real key to being able to profit from the method lies in the psychology you must use.

Because of the rules and what we look for when entering and exiting a position, the psychology attached to trend following can also be considered to be 'out of step' with what the majority of traders think. Some of these issues are as follows:
  • We discount intraday 'noise' on charts - we prefer to concentrate our energies on the big moves that make the big money;
  • Some of our most profitable days are when we do nothing;
  • Some of the days where we lose the least are when we do nothing;
  • Lots of traders like to go long at bargain (low) prices - we buy on strength;
  • Lots of traders exit longs when new highs are reached - that is when we like to get into the same position;
  • Lots of traders like to go short at expensive (high) prices - we short on weakness;
  • Lots of traders exit shorts when new lows are reached - that is when we like to get into the same position;
  • Lots of traders focus their energies on a high win percentage - trend following historically gives a win rate of about 40%;
  • When going long, lots of traders determine an exit price - our only target price is infinity;
  • When going short, lots of traders determine an exit price - our only target price is zero.
  • Lots of traders focus solely on the winning - trend followers focus on the losing (i.e. we cut losses short, and let our profits run, the majority do the opposite);
  • Traders want to be proven right on their opinions about the market - trend followers have no opinions on the market, and are simply concerned with making money.
As a result of the above, the psychological aspect of trend following makes it something that the mainstream avoids, and that is good, because we need these other traders to take the other side of our positions. And when the big trends arrive, we will be the ones pocketing the money.

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