Sunday, July 21, 2013

Sticking to what works for you

One disadvantage of hopping from one system to another is that you can end up confused and almost with too much information or knowledge. To make money, you need to know what works for you, and stick to it. If it does stop working, the question you need to ask is - have the markets changed, or have I changed?

Trend following is a very simplistic approach to the markets. It is based on the one simple metric that determines whether you make a profit or a loss - price and its movements. You do not rely or need indicators or oscillators. You do not need to understand chart patterns, which can be interpreted differently by different traders (a trader will tend to see what they want to see on a chart).

Occasionally I look at how I can improve my method, and consequently, its performance. This may be something to do with an additional longer-term trend filter, or some reference to price patterns. In some cases, yes they may improve performance - in others, they do not. So, I stick to what I know and feel comfortable with.

For example, after a prolonged trend in one direction, there will automatically be levels of support or resistance, ascending or descending trendlines, bull and bear flags etc. My argument is that, if the new price trend is for real, then price will go through those levels. If not, so be it. What have I lost? At worst, a small element of trading capital. I am not going to cut short a potential big winner just because price has encountered such an obstacle.

For example, in late March/early April 2009, I started getting a lot of long signals in individual stocks. I started opening positions. As it turns out, March 2009 was the bottom of the market. Had I been using a 200 day moving average as a trend filter, then I would have missed out on a huge chunk of profits. On a lot of those positions, prices rebounded nicely, going through broken levels of support on the way, which 'should' have acted as resistance on the way up.

One year earlier, while others were talking about a pull back in the market, I was loading up on short positions - signals were being given, support levels being broken. All I was doing was following price and its trends. It was that simple. I was not putting obstacles in my way.

I was not looking for ways in which the trade could fail. I knew what worked for me - to gain from the potential rewards, I was prepared to accept the risks. I saw the signals, recognized they were familiar to me, and reacted to them. Van Tharp's interview in Market Wizards covers this point.

Since I settled on my basic system parameters several years ago, I have only made one change, following a drop-off in performance in 2011. The change dealt with stop placement, and that followed a period of over a year thinking about it, and several months testing it with my own money. I do not make changes in my approach for changes sake. To quote Larry Hite, I am not necessarily looking for the optimum method, I am looking for the hardiest method.

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