Monday, December 31, 2018

Letting the downtrends run

Having more losing trades than winning trades is to be expected as part of a trend following process. 

Part of the joy of trend following is that you never know when you will end up in a profitable trade, and once we do, we have no idea how long the trend will last for, and also how far price will move in our favour.

Back in September and the early part of October, I took a number of short positions in UK FTSE 250 stocks which my scans threw up and met my criteria. 

This was not part of any great foresight I had, nor trying to pick any tops in the markets. I was simply observing what opportunities I was being presented with (and at the time there were far more on the short side than the long side), and then taking the entry signals when they triggered.

As I've said plenty of times before, I've no qualms about shorting individual stocks, even though plenty say it can't or shouldn't be done. To paraphrase Larry Hite in Market Wizards, I simply see risks, rewards and money. 

And I also had the experience of trading on the short side during 2008, and going through the volatility back then (which is still far higher than we have seen in 2018!).

Of course, some trades didn't work out - that's trend following. Typically trend followers have a win rate of 30% - 40%, but it is the magnitude of those winners and losers which are key to your overall expectancy. This is where the Golden Rule becomes so important. And I am very aggressive at cutting losing trades.

Of those winning trades, I am now only left in one position. The market (i.e. the other buyers and sellers) has determined that the trends I was attempting to profit from have run their course, and my trailing stops simply took me out of the trade at the appropriate time.

Let's look at some of these trades:

Easyjet gave a short signal right at the beginning of September, and ended up generating a profit of +4.26R. When the end of the trend came, there was quite a sharp rally creating a small 'V' shaped reversal after falling to new lows. I wasn't going to predict when the exit would come, and let my rules do the job for me.

Today, I was stopped out of my short trade in BAE Systems, which had been open since early October. While adjusting the trailing stop to account for the spread enabled me to stay in the trade in mid-November, the spread on the market open this morning got me and I was stopped out, meaning I was able to capture profits of +7.44R.

As a result of this I now have one short position remaining open, in DS Smith, which currently is showing an open profit of around +9.5R.

Again, all these trades (and those where the breakouts failed and I suffered small losses) were simply as a result of having clearly defined entry criteria, placing the orders at the appropriate levels, and then crucially allowing the trades to develop. Once in the trades, all I had to do was update my trailing stops as per my rules.

And the result is that the profits generated from these few winning trades far outstripped the losses suffered from the other losing trades.

Going forward into 2019, I have no idea what will happen in the coming days, weeks or months, so therefore I have no bias as to whether I will be trading on the long side or the short side.

As always, the focus for me is on sticking to my process, and I will let the results take care of themselves.

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