Sunday, November 05, 2017

Richard Dennis, trend following and leaving your ego at the door

The siren call of the high win rate strokes the ego of many traders, and this causes internal conflict amongst people who aspire to be trend followers.

Left unchecked, the ego within us would make the desire to be seen to be right its primary focus, rather than to make money. But this goes against the grain when it comes to trend following, where the typical win rate can be between 30% - 40%.

Richard Dennis once said that 95% of his profits came from just 5% of his trades. A review of my own trading records found something similar, and I guess many other trend followers would come up with a similar metric.

So why on earth would anyone want to trade using an approach that losses more often than it wins, where very few trades contribute to the bottom line, and where you can spend the majority of your time in a drawdown?

The answer to this lies in the following:
  • The principle of cutting losses and letting profits run is central to its success;
  • Risk management, both in terms of risk per trade and measuring portfolio heat is a key part of the rules;
  • It works in up and down markets;
  • It seeks to embrace volatility;
  • It boils everything down to following one simple metric that everyone can follow and understand - price; and
  • When a pronounced trend takes off, trend followers will generate massive profits. 
But to achieve this, you have to leave your ego at the door - no opinions, predictions or complicated analysis, no second-guessing thinking you are smarter than your method, and above all else no need to be seen to be right.

And therefore it is quite right to say that it is not you against the markets and the other participants, it is you against yourself.

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