Whenever a trend follower captures a big winning trade, outsiders often wonder if it down to pure luck, skill or something else?
In a lot of cases, trends can start to develop in spite of the current sentiment and beliefs of many of the market participants.
Trend followers however approach the markets in a unemotional state - if their method tells them to enter a trade at a certain price level, they enter. Similarly, if their method tells them to exit at a certain price level, they exit.
A trend follower would never get into a situation where they would allow price to start trending significantly in the opposite direction to that they are trading - witness Bill Ackman and the chart of Valeant Pharmaceuticals. If their exit level is hit, they get out, no questions asked, and move onto the next opportunity.
They are conditioned to exit based on price and their chosen parameters, not on opinions or beliefs about where the price on a stock or instrument may or may not go. In other words, they are slaves to their own system or method for getting in and out of their positions.
Now, there is undoubtedly luck involved in getting into a major trend on a sample size of one. And historically, trend following has a typical win rate of between 30% and 40%. However, trend followers work on the premise that trends have a tendency to persist. So, they take their entry signals at the start of a potential new trend. If they are wrong, they will know quickly and will exit as soon as possible, with as little damage as possible to their equity.
If however, they do get into a position where a significant trend starts to develop, then the only skill involved is having the ability to stay in the trade until an exit signal is given. They never predict when that will be, or at what price level. The price action in the market they are trading will tell them when that time has arrived.
Psychologically, it can be very difficult for people who start to use a trend following approach to truly grasp how it works until they have been through the myriad of emotions and cycle of market conditions that accompany such an approach: lots of small losses, some small wins, and the occasional big win.
Trend following is not an approach geared toward achieving a high win rate. You have learn how to lose (small) before you can win. It is not easy telling someone they are trading well when they are clocking up small loss after small loss. But that is all part of the game. Similarly, you also have to accept that hard earned gains can be lost as part of the process when a trend starts to end or reverse. Those who can understand and accept that, along with applying strong risk control, have the best chance of success.
I talked here about how a trader friend I've mentored for a few years went through this process. All his development, learning and initial frustration, in effect, was the precursor to making a big psychological breakthrough. But all through that process, he was sticking to what his basic method was telling him to do. It kept him in the game. It eliminated the possibility of big losses. He knew he was getting closer and closer.
I'll never forget the phone call I got from him when he managed to get into a few positions, the majority of which started to develop major trends. I was on holiday at the time, but we kept in touch as the profits were mounting up day after day. The urge to take profits off the table was huge, however he knew that would go against the basic premise of letting the profits run: "This is really testing my mettle", he said "but NOW I truly see and understand the power of trend following."
He now trades more than one trend following system on different timeframes and is making decent returns. Whenever we chat about things, he continually refers to being a slave to his system, and stresses to himself the need for him to not listen to his own thoughts and opinions about what may or may not happen. He continues to take the positions when he gets an appropriate signal and his risk limits allow, and then he lets the markets do its thing.
And that is the way it should be.