And the trend goes on....

This is what can happen if you stay patient when you are in a trend - the famed multi-bagger. No more words necessary.

Regularly critique your own trading

Something that I believe all traders should do is keep a detailed record of their trading activity, and more importantly, study it on a regular basis. This is regardless of their trading method. This can be done on your own spreadsheet (as I do), or there are some that are available for purchase on the internet.

If you have backtested your system, then a comparison to your actual results achieved can be enlightening - is there a problem with slippage? Do you have issues with gaps through your stops?

The Trading Triangle - discount offer

For a short period, I am offering a discount on my e-book, The Trading Triangle. Originally released in late 2010, the system has continued to perform well and generate profits despite the inevitable periods of drawdowns in between, and has helped a number of traders. Readers reaction has been positive - testimonials are here.

I am currently in the process of updating the e-book for release in the next month or two, which will cover both the shorter term and longer term trend following systems, which may appeal to swing-type traders as well as investors, as well as covering other areas of the system in more detail following feedback from readers. The price for the updated version will be increased to reflect the added value.

Anyone who has purchased the original version will automatically receive an emailed copy of the updated version as soon as it is available.

The price has been reduced to £20 for one week only, representing a saving of 33% on the original price.

Alternatively, remember that you can subscribe to the members area, where in addition to being able to download a free pdf copy of The Trading Triangle, you also gain access to the model portfolios, the message boards and the members' chatroom. To subscribe on a month by month basis costs £25, via Paypal, or, if you subscribe for 12 months, it works out at £16.66 per month. To find out more, click here.

A chart of two halves

I've attached an educational chart of the Nasdaq here to highlight the market states and how this affects trend followers.

 

In the first part of the chart, showing several months of 2011, you can see a general lack of direction, particularly from August onwards, coupled with the higher levels of volatility. Trying to trade this in a trend following fashion would have resulted in repeated exits due to the whipsawing nature of the market. This highlights a non-trending, volatile market - the worst combination for trend followers.

However you can see that since the beginning on 2012, it is almost as if someone has flipped a switch - a meaningful trend appeared, and the volatility has reduced right down. This therefore is a trending, stable market - ideal for trend followers as the volatility will make it highly unlikely for traders to be whipsawed out of a position.

The problem that trend followers have is that, with each signal, you never know whether a trend will take off. We do not try to predict - we simply act on the signals given. This in a nutshell explains how trend followers did very well in the 2008 - 2010 period, and not so well last year, and highlights the psychological barriers you need to overcome to be in a position to take the signals as and when they are presented to you.

Old, bold traders

There is a famous quote in Market Wizards from Ed Seykota: "There are old traders, there are bold traders, but there are no old, bold traders". What Seykota was referring to here was the higher degree of risk per trade that younger or less experienced traders seem to take.  

Training pays quick dividends

I met with Mark, a trader last weekend and did some 1-2-1 training, which has yielded some pleasingly immediate results. Following our session he went long on UK stock Mouchel Parkman, which as you can see has broken out very nicely into profit this week:

He has been kind enough to send me a testimonial as follows:

"I met with Steve last Saturday to discuss his system and help clarify my views on trend following. Steve was able to demonstrate why trend following works (with lots of chart examples) and why his system is best placed to benefit from this style of trading (including an explanation of the scans he uses). We went through lots of chart examples and he explained to me the importance of using proper risk management and utilising guaranteed stop losses to avoid hitting problems with gaps. Steve not only has a lot of theoretical knowledge of the trend following literature but also loads of real world experience to back it up. To meet with someone that has and still is trading a trend following system successfully is a great confidence boost. I recommend a 1:1 session for anyone who wants to understand how to make money trend following. Thanks Steve."

If you wish to consider learning how to trade in this fashion, then consider getting some training like Mark and learn how to effectively identify potential trends and to profit from them.

Can you stick to the rules?

I had the pleasure of a recent training session with someone who already knew about trend following as a concept, and had read of lot of material on the subject.

One thing that stuck in my mind as we finished the session was that, although he knew 'what' to do, the acid test would come when positions started to go against him - would he be able to hold his positions until he got an appropriate exit signal?

Proper risk management will help in this regard - as Market Wizard Larry Hite said, you need to have an 'emotional indifference' to every trade.

This is what I mean about trading is simple, but not easy. It is easy to see in hindsight what you should have done, but are you able to religiously take all entry /exit signals as required? The market is a harsh taskmaster.

In this regard, if you are a trend follower, you should consider something I did myself a while back - force yourself NOT to look at the markets during the trading day. That way, you can avoid making emotional, irrational decisions that you can live to regret. You can review your trading account in the evening, when the markets are closed, with no pressure to sit there and do something.

Overtrading

The biggest problem I see for new or inexperienced traders is not so much the basic trading strategy they choose to employ, but either trading too often if an intraday system, and/or with too much capital risked on each trade.

Part of the reason for this is that a lot of people go to free seminars or visit websites whereby people promise untold riches for very little effort, with pictures of large houses, expensive cars and exotic holiday locations. You can be sure that yes, traders can and do reach that level where their disposable income allows them to indulge in such luxuries, however to get there they will have employed strict risk parameters with regard to their trading activities. New traders see only the potential gains, not the losses that can easily be racked up.

For those with small pots of money, this problem of overtrading can be an issue if trading more than one instrument at a time, however you need to resist the urge to trade too often. It is for this reason that a lot of successful day traders use the 3 strikes and your out principle - if you have 3 losses, take the rest of the day off. This way it prevents you from trading emotionally in an attempt to recoup your losses, which can potentially lead to totally irrational trades, trying to 'force' the issue. For longer term traders or trend followers, you need to ensure that you do not plunge into too many trades, too quickly. If a meaningful trend develops, then there will be plenty of time to enter good looking set ups. Particularly in a volatile general market environment, this will help avoid a short sharp drawdown in the event of a quick reversal of trend.

In my opinion, the best way to proceed is to learn a trading strategy that has positive expectancy, and to use proper risk management. It is far better to get the building blocks in place at the beginning, rather than make these basic mistakes (which can make you blow up and destroy your trading account) and use the power of compounding to increase your position size as you progress.

Trading is a marathon, not a sprint. It is simple, but not easy. Trading capital is your livelihood, and your first thought on each trade should be to quantify your risk. If you doubt me, then flick through a book like Market Wizards and see how many of these famous traders talk about controlling risk as their main goal. In nearly all the interviews, they talk about their big losses which was when risk got out of control. Control the losses, and the gains take care of themselves.

Discretion in a mechanical system

In every mechanical trading system there is an element of discretion. This relates to the parameters set by the trader - the specific rules for entry, exit, and the risk levels to trade at are just some of these elements.

In addition, there is the question of what instruments you wish to trade. Traditionally, trend followers have traded a basket of commodities, futures, forex etc, and basically took every signal generated within that basket - NOT taking every signal could mean that the one big trend in the year could be missed, ruining your bottom line performance.

As I tend to trade stocks, I am not restricted to a small basket to look at. The scans I use mean I can look at thousands of UK, European and US stocks and identify potential candidates that meet my pre-set criteria in a matter of seconds.

Suppose a scan is run and a selection of 10 stocks come up which meet the pre-set criteria. Of those, some may be considered too volatile, others may have a spread that is too wide, as well as the general 'look' of the chart - these are all personal preferences for which guidance can be given, but there is no hard and fast rule. Once those stocks have been discounted you are left with perhaps 2 or 3 candidates - again, selecting one of those for your trade may again come down to personal preference.

In addition, no one trader has sufficient funds to trade all the opportunities that are presented to him, and an experienced trader will allocate their risk per trade over a number of positions, as well as limiting his overall risk exposure at any one time. This again is a discretionary element that can determine whether you are able to open a new position that is presented to you.

There have been some recent stocks that I identified in the members chatroom or put on my watchlists, but did not take the trade when the entry signal was given. And as is the way, they took off and have not looked back - Bango and Dryships are just two from the last few days that spring to mind. I, on the other hand, selected other stocks that came up on the scan at the same time, and they have moved very little, or even reversed. Such is life. However, I know that, over a larger sample of trades, by staying faithful to the scan criteria I use, I will select stocks that will perform very well for me.

For example, I opened a long position on a stock early this morning, and that stock is now almost 15% up on the day. Another stock I currently hold is up over 10% on the day as I type this. Lucky? Over a sample size of two, then yes, but as part of a large sample no - I saw the stocks come up on the scan, and a quick look at the chart confirmed these were stocks I wanted to trade, so I opened the positions.

Putting you in control

I have been asked on more than one occasion why I do not provide a trading signal service. The answer to that is I feel it is important that people fully understand how all the components of the system work together, together with the reasons why trades are opened or exited. Certainly, I would feel uncomfortable blindly following another trader's signals without a thorough understanding of what they are looking for.

It is also a easy get out when a trade goes wrong to blame someone else for losing money. Having all the rules to hand mean that the ultimate responsibility for making profits and losses lies with the individual pulling the trigger. You'd be surprised how often traders or investors do not take responsibility for their own actions - the easy way out is to follow someone else.

The Trading triangle e-book, as well as the training I give to other people, have been designed to give YOU the framework to construct a trend following system suitable for trading stocks, using the essential core elements, and to give you the tools and knowledge to understand what makes a great set up, and what to avoid.

Kofax

Another UK stock that I mentioned last week in the members area, going onto my watchlist, was Kofax. As you can see, this has also broken out nicely the last few days.

There are plenty of trading opportunities almost every day in the current market - if you would like to pick some of these great opportunities up, then be sure to sign up to the members area, where you can download a free copy of my e-book, giving you the scan code that idenitifies these set ups.

The first thing you should think of before every trade

When designing a trend following system, there are a number of parameters that must be set - basically how to identify an entry and exit point, inital stops etc. But the most critical aspect relates to the amount of risk you attach to each trade.

BANGO plc

I called BANGO plc as a good long set up in the members area the other day when it broke out at the 80p level. Although I didn't take this trade, the chart makes tremendous viewing, with the stock up almost 40% today alone as I type this, and up the best part of 80% in a matter of days.

What's in a name?

A competent trend follower would be happy to place a trade regardless of what instrument or stock satisifes their criteria. Indeed, I can place trades on stocks without even necessarily noting the name of the company, other than for record keeping purposes. Often I do not even know what type of business they are involved in. If the set up fits, then I simply place the trade. In this manner, I avoid getting emotionally attached to any particular stock - it is simply a vehicle from which I cam potentially make money. It also saves hours poring over fundamental reports, studies of price to earnings ratios etc.

Although fundamentals can be a contributory factor, they do not solely generate profits for traders - movements in their share price do. If you doubt this, remember the dot com boom - if you ignored the dramatic increases in share prices (which in a lot of cases the companies concerned had absolutely no earnings or profits to report), then you would have missed out on those tremendous gains achieved in a relatively short period of time. And with a good trend following system, adhering to your exit signals would have ensured that you have banked the majority of those gains, only closing your positions when those huge run ups had exhausted themselves.

A good trend following system means you can trade stocks, indices, commodities and forex without basically changing any of the system rules. There is no over-optimisation of the parameters required for individual types of markets. If you are presented with a chart that satisfies your criteria, you would not even have to know what it is you are trading. It is because of this that trend following is the hardiest method to generate profits from your trading activities.

Act accordingly on a proper change of trend

"Every truth passes through three stages before it is recognized: In the first it is ridiculed; in the second it is opposed; in the third it is regarded as self-evident.”

I came across this quotation today which sums up very well the stages that the majority of investors and traders go through, particularly with regard to a change in trend.

This can be seen very clearly where investors are discussing a stock in which they have invested heavily. The fundamental story may be compelling, but if the stock continues to fall in price after they have bought in, then they are losing money - fact.

In the past I have exited positions in a stock (for a profit) only to be ridiculed by investors holding onto a position, however the charts gave me a clear exit signal. In the months following my exit, those that have held on end up having to resign themselves to sitting in a loss for a while - the easy 'ten bagger' they were banking on is in a clear downtrend and, rather than cut their losses, they are now sitting on huge paper losses (which incidentally I consider to be a very real loss).

After a while, they then resign themselves to the fact that there is no future prospects for the stock, so they either a) leave the position open but try and forget about it or b) sell up. Even then, they normally try to see the positive side of this by saying the capital losses incurred can be offset against profits made elsewhere, thereby reducing any tax liability. Quite often they exit the position right around the time when the trend reverses back to the direction they originally wanted.

Just on this issue (which is slightly off at a tangent) I'm not sure what others think, but if I was trading shares in the traditional sense then I'd be more than happy to pay any tax on profits - like a trend follower suffering losing trades (which are restricted as exits are made strictly in accordance with exit signals), tax should be considered a cost of doing business. Particularly in the current economic climate, paying tax means you are making profits - what's so bad about that? Of course, I trade using spread bets (available to UK residents) which are tax exempt :)

Anyway, to get back to the main topic here, to me it seems that a lot of investors suffer a period of self denial when a stock goes against them - "I am right, the market is wrong - I will be proved right" - that kind of thing. There is an emotional attachment which is poison - the market doesn't care whether you are long or short a particular stock - it responds to ALL participants. It should be remembered that the market, and the price fluctuations are the sum of ALL market participants, and you have no idea of anybody else's trading timeframes, the reason they have put their positions on etc., so if the price goes against you, then you are on the wrong side of the trade.

As a trend follower, you simply follow price, so you are automatically taking every market participant's opinion into account. If a price is trending up, you should be long, and if its trending down, you should be short. Simple.

I went long on a particular UK stock yesterday, only to be 'advised' on a bulletin board that "I can tell you this one is still down nearly 50% with little hope of recovery whatever charts you are reading". Well, if I am wrong (which I frequently am) then a 1R loss is simply a cost of doing business, and I will move on to the next candidate. Why did I buy this stock? Because it is breaking out to new highs, signalling a potential new uptrend and satisifed the criteria for my stock selections. What else can a trend follower do? So I've been ridiculed for taking the trade - time will tell if price moves in my favour or not.

Counter trend traders, and those who like to call market tops and bottoms, also go through this three stage process. Some of these traders I have read about seem to do well for a while calling market turns, gaining a following, and then, as so often happens, make some pronouncement about a big market turn - only for the trade to go against them, and their followers, who like a herd of sheep have blindly followed into the same trade. Even worse, the trader with the following does not even use stops, and preaches patience before the trade will come good. Well, as this particular trader I'm thinking of trades ETF's and indices, he is massively underwater, and no doubt some of his followers have blown their accounts.

Trend following is considered a boring, not very glamorous way of participating in the markets. I don't trade for excitement, I trade to make money. The whole purpose of trading such a system is that it gives you very clear guidelines of when to get in a trade, and more importantly, when to get out of a trade - if it means taking a loss, so be it. Move on. However, a trend follower, if they have set up a proper system including approporiate risk management parameters, will avoid these massive blow ups, as well avoiding the issue of holding onto massive losses in the hope that they will turn round - someday. The first loss is your best loss. Of course, we cannot avoid a drawdown from a series of losing traders, but that is part of the process of finding the big winners. Every losing trade brings me closer to a winning trade.

A trend follower will therefore avoid having to go through those three stages mentioned at the beginning of this post. The truth is in the price, and we act accordingly upon what price is saying. We control our losses and do not restrict our profits. So we never get in at the absolute bottom or top of the previous price move - so what? Price is the only thing a trend follower needs to worry about.

Training testimonial

I went to London recently and had the pleasure of spending a day with Derek, who was keen to learn about trend following. This is what he had to say:

"I recently had the pleasure of 1-2-1 training from Steve and found the day excellent value. Steve is very knowledgeable, clear in explaining the concepts of the system and was very open in sharing his trading experiences. After setting up the scans on my home pc we covered risk management, loads of chart examples, adopting the correct mind-set and the importance of recording results. As a result I was literally trading the T3 system profitably the next day after training. I was impressed by the key emphasis on keeping it simple, after all it's following the system that will work in the end."

If you are interested in following Derek, whether you are a trader or an investor, please consider some training or look at enrolling in my mentoring programme.

The psychology of trend following

A well thought out trend following system adheres to the KISS method (keep it simple, stupid!) but, for a lot of people, it is not easy to follow. 

Ed Seykota, in his Market Wizards interview, referred to the fact that having a screen on your desk is like owning a slot machine. He simply ran his scans, on an end of day basis, and placed his orders accordingly. The gyrations of the market throughout the day were left for others to worry about. He simply identified a trend, and acted on it.

Onwards and upwards?

The price action of the last few days has had some people suggesting that a market top is now in place. The alternative point of view that this may a small consolidation/pullback before the uptrend resumes. If you asked 100 different traders, you would probably get 100 different answers, with many of them giving differing targets (either in an upward or downward direction), along with pretty sqwiggles drawn over some charts showing how prices will move over the coming days and weeks.

As far as trend followers go, we do not look for price levels as targets before exiting a position. We also do not predict how price will move within a trend. We simply identify a potential new trend, enter a position in accordance with our rules and stay with it until that trend has ended. Currently, the trend remains up, and as I have very little market exposure at the moment, I will continue to trade new positions on the long side as and when they appear.