Saturday, September 07, 2013

Timing is (almost) everything

It should be clear to everyone that trend followers need trends to appear in the market. No tradable trends, no profit. There are four basic market states - trending or non-trending, stable or volatile.

When the markets are in their most favourable state (stable and trending), it is those periods that can generate the most profit. Similarly, when conditions are not favourable (a non-trending, volatile environment being the worst) then performance will not be as good.

Below is a chart of the Dow covering the last twelve months. Now, suppose you have two traders who are trend followers. One started using the system in late 2012, the other in early May 2013. Which do you think would have achieved the better performance?

To make money, trend followers need a trend! As I concentrate on individual equities, you find that these can develop trends at any time, and in any direction. However, it becomes a lot easier when your bias is in line with the direction of the general market, as it provides a degree of support to your own positions.

Look again at the Dow chart. We can clearly see that since May, there has been an increase an volatility followed by failed attempts to develop new trends. In short, the worst market conditions for trend following. Compare that to the upwards move off the November 2012 lows. For several months, conditions were the opposite - a relatively stable trending phase.

This is reflected in my own performance - last month overall returns regressed slightly, and in the late May/early June phase I had a run of (small) losses, combined with an erosion of open profits. Up until the last couple of days, I have not had any US position for 2-3 weeks. However, in July I was able to generate big returns, partly as a result of some existing long positions that survived the May/June volatility subsequently making decent moves.

Quite often you will read interviews with traders who say something along the lines of "I started making money straight away, and I thought it was easy", only to suffer major losses down the line. To be successful longer-term, you must heed the lessons learned. You must also accept there are periods where you will perform better than others. You can only take what the markets are prepared to give.

This happens even to the best. As famed trend follower Ed Seykota referred to in his Market Wizards interview, one of his worst years was 1980: "I had never seen a major bear market before, so I was all set up for an important educational experience".  

Seykota did not ditch his system, he retreated to the sidelines, observed what has happening, took stock (pardon the pun!) and ultimately profited massively from the experience.

The purpose of the mentoring programme lasting one year is so that traders will be able to see how the system performs under these differing market conditions, and that myself (and the other members) can provide the benefit of their experience.

I started working with two of my most successful students at points where the markets went from a trending to non-trending state. Almost from day one, they were in a drawdown. Yet they had the confidence and discipline to stick with system, and accept there are periods where the system does not perform as well as others. The result is that both those traders are now comfortably ahead (refer to this case study about one of those traders and their development).

To put a positive spin on it, if you are able to stick to the system and keep your losses to a minimum when market conditions are not favourable, then you will find it a lot easier when a decent trend does develop. And, as sure as night follows day, a meaningful trend will develop in the general market following a period where there were periods of volatility and congestion. This will make our task a lot easier.

We are currently sitting on a whole host of identified setups waiting to trigger. In the last couple of days, one or two have given the appropriate entry signal, and have already started moving in our favour.

As one new member commented to me "since the market is currently difficult as you say, it could be a good moment to join the group and get familiar with everything". On that basis, Why not follow him, before meaningful new trends develop, and sign up to join our team?

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