Friday, August 15, 2014

Focus on price not opinions

One of the joys of being a trend follower is that you are never married to a position or an opinion. Price trends both in the indices, as well as individual stocks, can and do change in a relatively short period of time. You can be long a particular stock for a period of time, only to switch and trade it short a few weeks later, or vice versa.

Trend followers do not care about being proven right on a position - all they care about is making money, and they have found over time that, by following the trend, they can do that. No ego is involved in a buying or selling decision. They also try to have no opinion. If price is telling them that a market is attempting to go in a particular direction, they will follow. So, if the trend changes, this allows them to close off old trades and open new positions in the opposite direction.

If a trend follower ends up on the wrong side of a market, so what? They just exit the position and move on. There's no hoping that price will turn back round and start moving back in the direction they were trading. They just get out of the position, or in some cases, open a new trade in the opposite direction.

Because of this, you will find that trend followers will have extremely robust risk control. It is an inherent and critical element of their overall trading plan. It has to be, to deal with the periods of non-trending markets which can lead to whipsawing.

It is entirely possible for trend followers to endure weeks or maybe even months of non-performance, before markets suddenly click, and they get into a number of winning trades. It is in those periods where the big surges in returns are made.

It is those tricky periods of non-performance that cause people who do not have the proper risk control and the correct mindset tend to fall by the wayside.

Trend followers basically fall into two camps:

a) Those that are always in the market, long or short - this is basically a stop and reverse system, used by people like Bill Dunn at Dunn Capital. As he refers to it, it is akin to 'riding the bucking bronco'. This approach can lead to periods of drawdown or whipsawing around if their chosen markets are in a non-trending state. However, you can guarantee that when a new trend does take off, they will have got in right at the start of the move.

b) Those who look for a degree of strength before going long, or weakness before going short. These types of trend followers can be out of a market during a non-trending period, and try to enter when the trend has gotten under way. The Turtles method of trading, and indeed my own approach, is based on this idea.

Either way, trend followers should have no issues about going long or short, or even staying out of market if they fall into the second category. For them, price and its movement is the only thing that matters.

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