Saturday, May 18, 2013

Trend following - a system for all seasons

The markets have given plenty of opportunities on the long side over the last few months, if you were able to follow the trend. The tricky bit will be when the markets decide to reverse trend. Will people be able to heed an exit signal, bank their profits, and either move to cash or look for possible shorting opportunities?

Nobody knows what the markets will do over the coming weeks or months - I've seen two headlines this week with 'Analysts' calling for the Dow to end the year either at 17,000 or 11,000. As Ed Seykota famously said "I don't predict a non-existing future". All we know is that, at some point, there will be a market downtrend, and even then, no-one will be able to predict the magnitude or speed of it. Could be next week, could be in two years time...

When there is a clear market uptrend such as now, then systems such as trend following tend to be overlooked as a method for making money. The BIG advantages that a trend following system has is that:
  • It will give you clear signals when to get out of a stock or market, when price is trying to reverse trend;
  • It can also give you the opportunity to make money when the markets are trending downwards;
  • It will only give you signals to re-enter on the long side when the trend is trying to reverse (no attempt to pick a market bottom).
Trend following systems only tend to come back into fashion when markets act like they did in 2008. That is when those who try and pick market bottoms continually get stopped out, and those who believe in 'buy and hold' manage to lose a big portion of their hard earned profits. Trend followers will be sitting on the other side of those trades, and will be making money. And if you doubt that, go look at some charts from 1929, 1987, 2000 and 2008.

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