Saturday, September 15, 2018

Trend following - a simple way to playing the long game

Warren Buffet once said “There seems to be some perverse human characteristic that likes to make easy things difficult.”

A good trend following approach allows you to participate in the equity and other financial markets eliminating a lot of the difficulties.

Your basic rules will tell you:
  • what to do;
  • when to do it; and
  • how much to risk.
You can trade 'parrot-fashion'. No opinions or predictions are required. You simply follow price, see how it interacts with your chosen entry and exit parameters, and only then do you need to do something.

It is often said that trend following is simple, but not easy.

That's not strictly correct. It IS easy - providing you have the right attitude and mindset. And that may well need to separately be worked at, developed and maintained.

People see the historical returns that trend followers have been able to achieve and think they want a piece of that.

Then they read a set of rules used typically within a trend following approach, and they may think "Hmmm... that's simple - I can do that. How hard can it be?" *

The difficulty is that, to get to that end result, you have to look at the bigger, long-term picture - the shorter-term results and equity fluctuations become irrelevant. 

Think of the famous marshmallow test and see how it applies not only on a trade-by-trade basis, but also how, as a trend follower, on an equity level you HAVE to expect periods of poor performance and learn to embrace them as a means of achieving longer-term profitability and equity growth.

As an example, I was recently listening to a podcast where a famous trend follower was talking about the attitude of some of his clients during the volatility spike earlier this year. Some seemingly couldn't wait to head for the exit door, or were trying to tell him what he should be doing and suggesting changes to his approach (?!?). 

However, a few were calling him and effectively saying "We know what can happen in periods like this - just keep doing what you've been doing. We know we will win in the long run."

Trend following can be seen as 'old hat', and its practitioners always have this battle against the short-termism or micro-managing attitude of others, so they can get to the delayed gratification.

In other words, to come out ahead over the long haul, as a trend follower you have to have patience, discipline and commitment. You have to accept you will lose more often than you win. If you can do that, then you have a chance.

As Richard Dennis famously said:

"I always say that you could publish my trading rules in the newspaper and no one would follow them. The key is consistency and discipline. Almost anybody can make up a list of rules that are 80% as good as what we taught our people. What they couldn't do is give them the confidence to stick to those rules even when things are going bad."

So, if you are a short-term fantasist who wants to make a return of hundreds of percent by this time next week, you're looking in the wrong place.

If you want to brag to your mates on social media about having a 90% win rate, go read something else. We don't look to capture 5 pips on a tick chart while risking 20 pips.

If, however, you want to use a simple, robust, historically proven method which can capture both uptrends and downtrends without having to be glued to the screen all day, then trend following may be for you.

* Others will think "that won't work - far too simple", but that's a different story...

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