Tuesday, September 29, 2020

Losses and Whipsaws - one good trend pays for them all!

Any aspiring trend follower should expect runs of consecutive losing trades to be the norm, interspersed with the occasional small winner and, every once in a while, a big winner.

At some point, most people tend to look for some silver bullet to eliminate at least a chunk of those losing trades, and get the win rate up to 50% or even better.

But the harsh reality is that, throughout history, the most successful trend followers have prospered with a typical win rate of between 30% to 40% - irrespective of timeframe, or the markets traded. That, combined with a method allowing the cutting of losses and the ability to let profits run is from where the positive expectancy of the approach comes.

My own experiences, and the process of winning and losing money over time have forced my own ego to accept there is no need to be proven right on any one trade - its just part of a large sample. If I lose on a trade, its treated as the cost of doing business, and I move on.
These days, I've even got to the point of automatically assuming that the amount risked on each and every trade will be lost. Adopting this mindset this might help some people avoid taking excessive risk of any one trade.

But combined with this, I am very aggressive in cutting my losses, and the vast majority of my losing trades do not end up resulting in a full -1R loss being suffered.

This cutting of losses also helps in ensuring my capital is not tied up in losing or non-performing trades. I like to get shot of them as quickly as possible. I never want to get into a situation where I look at my trading account and be confronted by a big ugly loss sitting there, where a trade had turned into a longer-term 'investment'.

Every so often, I can get 'whipsawed' around, in a market where there is a clear setup which meets my criteria, but after my entry is triggered, price does not move in my favour and I end up getting stopped out, repeatedly, for a small loss.

While frustrating, whipsawing is to be expected when utilising hard and fast entry and exit rules.
As I trade price breakouts, that is the trigger for me getting into a trade. When price reverses in the opposite direction and puts me in a loss (after adjusting for the spread), that is a clear signal, even without looking at the chart, that breakout has failed, and the reason for entering a trade is invalidated. So I get out.

I'd far rather bank a small loss and move on, instead of letting the trade run in the hope it might turn around back into profit. The latter option always risks the potential for a small loss to grow.

But if the setup re-establishes itself and still meets my own criteria, there is nothing to stop me from re-entering again at the appropriate time and price level.

As famed trend follower Bill Dunn says:

"We just ride the bucking bronco."

Similar to dealing with losses, bouts of whipsawing are to be expected, and the only way to avoid these scenarios is to stop trading.

In his book Way of The Turtle, Curtis Faith talked about a series of cocoa trades in from April 1998 into early 1999. Setups (long and short) kept being presented and ended up generating 17 consecutive losses - and an accumulated loss of -40.3%. 

On the 18th trade, a 75% profit was returned. Then followed another three losing trades totalling -8.1%, before another big winner of 67.2% came along. Then another two losing trades totalling -5.9%. Then another big winner of 46.7%. Then a further two losing trades of -4.2% followed by yet another winner of 42.8%.

For any aspiring trend follower, the question is this: 

When in the run of 17 consecutive losing trades, would you be able to keep taking those valid signals when presented?

Three inter-connected lessons you can learn from this example:
  • At inception, you can never tell whether a trade will be a winner or a loser - there is no way to predict;
  • Good risk control, and the cutting of losses, allows traders to contain their drawdowns as far as possible, and keep the equity as high as possible which will enable them to profit handsomely from a big future trend; and
  • As Ed Seykota is fond of singing, "One good trend pays for them all." One good trend, that is allowed to run with no profit 'target' being used can enable you to not only cover the losses and any bouts of whipsawing, but move your equity to new highs, allowing a recovery from a prolonged drawdown in double-quick time.
It's not called the Whipsaw song for nothing!