Friday, November 23, 2012

What a great week - not!

If you asked a trend follower what is the worst set of market conditions they have to deal with, then clearly a non-trending, volatile state is top of the list. A close second to that, and which we have encountered over the last week, is the 'V' shaped reversal.

The chart of the Dow below clearly shows an abrupt reversal in price, and the inherent parameters used in a trend following system struggle with this pattern. The parameters are designed to allow a certain amount of 'wiggle room' that occurs during a trend, to ensure that you are not stopped out on a minor reaction. However, when you get such a reversal as we have seen this week, then open profits can quickly turn into losses, and stops can easily be triggered.

My bias going into this week was to the short side, given that all the major indices I track had given short signals.

I'm not too proud to say that my portfolio has struggled this week, with a number of positions being closed at a loss, and consequently a drop in the performance metrics I keep track of. To add insult to injury, the long positions I do hold have not made ground either, so I ended up with the worst of both worlds. However, prudent risk control allows you to keep in the game when such market conditions occur.

What I would say though is that, on the indices, the pattern of lower highs and lower lows is still intact, despite the rise over the last few sessions.

It would appear that those who bet on such reversals have taken the profits over the last week. However, those traders who bet such on such patterns would have also lost heavily had the trend developed further. I don't have a crystal ball to predict such a pattern.

It is weeks like this that can test anyone relatively new to trend following. It is not a 'system death' but simply a set of market conditions that are not conducive for my system to generate profits. All I can do control those factors that I can control - namely, ensure that the positions I take satisfy my entry criteria, and have a sensible level of risk attached to them. In Larry Hite's words, they are 'good bets', even though they end up generating losses.

Once I place a trade, I am at the whim of the market, and all its participants, to see if the trends develop as intended. On this occasion, they did not, with the resultant losses. However, I know that if I keep following the rules, then in the long run this will be seen as a minor blip. I have the confidence and experience having traded the system over a number of years, and through the varying market states, that profits will be made. I also know that, after incurring losses, I am closer to making profits - may be significant ones. Therefore, I will dust myself down, accept the potential risks that go with chasing the potential rewards, and see what next week brings.

1 comment:

  1. Hi Steve,

    Great post. Of course it's a bad thing when portfolio struggles but then again, this is the system and those things happen. It's the market and out of control, deal with it. Tight risk control is key! Think I get it ;-)

    regards william