Saturday, January 05, 2013

Trend following - slow, slow, quick quick, slow

I had the pleasure of a long conversation with another trader last night, who is in the mentoring programme, talking about his recent trading performance.

What has astonished him was how, in just a matter of days, the drawdown incurred over the last two or three months has been wiped out so quickly, and an overall profit has been achieved. It brought home again how critical the risk and trading psychology elements are to generating profits in the markets.

We agreed that it's an awful lot easier to follow the system rules (and therefore have the correct mindset) when your risk parameters are under control - the question of entries and exits are almost an afterthought. As Larry Hite said in his Market Wizards interview, it's good to have an 'emotional indifference' to each position, but this can only be achieved if your risk per trade is set at appropriate levels.

Of course, this is nothing new to me, having traded the system with the same parameters for a number of years. As I posted here, a quick overview look at the indices shows the lack of a decent trend over the last couple of years, certainly compared to the four or five years prior to that.

It is to be expected therefore, that there will be periods of relatively poor performance when there are no trends to follow. It is the nature of the beast. However, by controlling risk, it keeps the bulk of your trading equity intact so that, when market conditions improve, then you will be able to maximise your profits.

Trend followers need a trend to make money. As I trade individual stocks, it has still been possible to generate profits, but it is certainly easier to do this when there is an underlying trend in the markets.

It is also a truism that, when utilising a trend following strategy, a relatively small percentage of your trades will generate the overall profit achieved. The remaining majority of trades will cancel each other out. This also work in terms of time periods - when a big trend takes, you can make a lot of money in a relatively short period of time. When a major trend such as the downtrend in 2008 hits, or the 2009-10 market uptrend, then a trend follower simply needs the ability to simply follow the rules, and can make big profits.

As for my trading friend, all he has to do now is simply update his trailing stops as per the system, control his overall risk, and remain alert for any other potential setups (like me, he limits the number of trades he can open on any given day).  But, he has only been able to attain these profits by having the emotional strength and underlying confidence in the method to go through the poor performing period, in order to gain the rewards.

Finally, a brief mention about the current state of the markets, I'm not an economics expert, and do not profess to follow all the ins and outs of the Eurozone crises, the fiscal cliff, or any other catalysts which may affect the markets. I simply follow price. What I WOULD say is that, since the March 2009 lows, and all the economic issues that have been in the news since then , we are still relatively close to highs on the major indices - indeed, the Russell 2000 hit new all time highs this week. The DAX is up to levels not seen since early 2008. The FTSE went through the 6,000 level this week with no struggle. Maybe the markets are telling you something...

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