Wednesday, July 18, 2012

A trend followers' peaks and troughs

A graph of trend following returns create trends themselves, as they suffer peaks and troughs, depending on a number of factors, such as whether there are potential trends to exploit both in the general market and in individual equities, current levels of volatility, etc.

When your trading universe is potentially 10,000+ stocks worldwide, there can also be an element of luck when selecting one stock over another, even if they have an identical set up. This is in contrast to a more ‘traditional’ trend following system, which covers a small basket of indices, commodities, interest rates, forex etc and you are required to take ALL signals generated. Over time and as the number of trades completed increases, the luck element becomes less of a factor.

I’ve had peaks in the past when my win percentage is up around the 80% level, and troughs where I’m struggling to get a 20% win rate. These extremes usually occur during strong, stable market trends when things are going well, and when you encounter high periods of volatility and/or trends are in the process of reversing when suffering losses. In overall terms though, there is an inherent positive expectancy in the system. Psychologically, you need to accept there will be both winning periods as well as losing periods, and that strict risk controls will restrict the losses in those losing periods.

It would seem that currently I am on a bit of a winning streak, in spite of the uncertainty in the general market. I commented in the protected Twitter feed last week that there was a dearth of good looking set ups worth trading, and to keep your powder dry. Since then several set ups have been called and acted upon which are currently in profit.

In addition Supergroup gave a signal last week but, for reasons I explained here, I did not take the trade myself. As I type this, Supergroup is up over 30% since the signal as given. Other potential set ups have been alerted but have not been acted on if not triggered.

Trend following is not the mythical ‘holy grail’ system in what a lot of traders go in search of, but to ME, it is a holy grail system in that it gets me in early on a potential trend (thereby maximising the potential reward compared to risk), keeps me on the right side of major moves, controls my risk when I am wrong (which can be more than 50% of the time) and yet keeps me in the big moves when I am right, creating the overall positive expectancy.

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