Tesla - letting the big trends run

The recent price rise in Tesla is just another example where people who got into the uptrend, and been able to let the trend takes its course, have been able to profit handsomely.

Here is that chart. Based on my own entry and exit rules, entering on 13 December at the $363 level would have generated open profits of more than +22R as of now, with the peak being at over +31R in February. If ever you want an example of letting your profits run, this is it:

Using volatility contraction to increase your profits (part 2)

Following on from my previous post about the use of volatility-based position sizing, here is a little wrinkle you may want to consider:

Typically this type of position sizing method is calculated using a multiple of Average True Range over a specified 'look back' period, and is normally expressed as a pure monetary number. So, in the second example in the previous post, Stock B priced at $20 had a 2ATR reading of $1.

Using volatility contraction to increase your profits

Often you see people talking about a winning trade, and how far in percentage terms price moved in their favour after entry.

But on its own, this doesn't tell you anything - to me, it is a worthless metric when evaluating performance.

As a trader, I'm far more interested in the size of the profit (or loss) generated when expressed in terms of R.

Using Bitcoin as an example of why I love volatility contraction

On my last post, I talked about the recent big winning trade in Bitcoin on the long side from earlier this year,which generated a +21R profit. Yesterday, Bitcoin gave a short signal as price dropped. 

Would I have taken this signal? 

No. 

Let me explain why.

You think the markets are volatile? Think again...

I've mentioned a few times this year, both here and on social media, that the current levels of volatility may seem quite high (certainly compared to the more 'normal' recent levels), but these are nowhere near the levels seen in 2008.

To show what I am talking about, at the bottom of this post I've shown the monthly chart of the Dow going back to the early 1970's. And then, I created a simple measurement to show the change in volatility, by taking the typical 2ATR measurement calculation and expressing this as a percentage of current price.

Ten years on - the critical lessons I learnt from 2008

Ten years ago the equity and financial markets were in the middle of an unprecedented period. My interactions with the markets around that time were the ultimate proving ground for putting into practice what I had learnt and developed over the previous few years, and my experiences over those few months helped propel me forward as a trend follower.

Some of it wasn't easy, and some lessons learnt (and re-learnt!) cost me money. But in the long run, the tuition fees paid have been covered many times over.

Here are some of the lessons I learned from that time, which still form part of my overall approach:

Some thoughts on volatility

Below is a chart of the Dow where I have zoomed out to show a longer-term view going back more than a decade. This shows that the current levels of volatility (as expressed by the 2ATR measurement) have only been reached three times in the last 8 years:

• August 2015 - when there was a short, sharp movement downwards which got quickly repelled;
• August 2011 - ditto
• 2008 through to early 2009 - when we were in the throes of the financial crisis and the big market downtrend.

A broader perspective on 2015

So that's another year come and gone - and one of the weirdest from a trading perspective. I've seen one or two people refer to 2015 as 'The Year of the Failed Breakout', and I certainly wouldn't disagree with that!

I can remember that moving from 2010 to 2011 seemingly changed the state of the markets from a trending to a non-trending state - certainly on my preferred timeframe. It was literally like someone had flicked a switched on 01 January.

These kind of changes can occur at any time, and when they do, we never know how long the new market state will last for. And, in the case of the markets switching from a non-trending to a trending state, we do not know what the magnitude of the new trend will be - or initially even the direction it will take.

The mathematical side of trading

When most people talk about how they approach the market, they refer solely to their style of trading.

In my own case, I follow price trends - I wait for a potential new trend to be signalled, and I will then 'hop on' for the ride.

However, there is another important factor you should consider, which is all to do with the mathematical side of trading.

A three point plan for long-term success

Providing you have got a method of trading which has a positive expectancy, here is a brief three point plan which will keep you moving forward on your trading journey:

A wild week

This week has certainly been a wild ride - predominantly to the downside. There was a quick 300 point rally in the DAX this morning but that was quickly eroded, with price now back to the overnight lows.

This is a microcosm of what market downtrends tend to be like - sharp relief rallies followed a further lung to the downside.

How I use volatility as part of the selection process

I don't use any of the classical indicators or oscillators that you see on many chartists screens. The price channels you see denote where entries and exits should be taken. To me, price is and always will be the ultimate indicator. Price and its movements will tell me when a trend is starting or finishing.

How to keep open equity risk in check

In my own experience, the biggest problem I've seen with relatively inexperienced trend followers is the question of stop placement in an open trade. 

Most trend following systems are used on commodities, FX and indices. I tend to trade stocks, but there is an added complication here in the effect of opening gaps, widening of spreads etc, which need to be factored in when looking at stop placement.

There is a secondary question as well - the risk to your trading account increases when a position goes in your favour. Let me explain.

Volatility and the markets

There are basically 4 combinations of states that the markets can be operating in:

1. They are either trending or non-trending;
2. They are either quiet or volatile.

Trend followers prefer quiet markets that also trend. Day traders prefer volatility. Swing traders prefer volatile trending markets to catch swings from a couple of days to a couple of weeks.

My trading rules

My trading system suits my personality and my desire to catch potentially large losses, offset with keeping losses small.

My rules are fairly simple in that long positions are taken when breakout above an 20 day high is made, while the position is closed when a 10 day low is reached. For short positions, the process is reversed. I use a multiple of the Average True Range measurement to help calculate where to place my initial stops. Once the position moves into profit, I use a trailing stop based on the low of the last 10 days.