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.

Some words of wisdom from David Druz

David Druz is a long-time trend follower who was the first mentee of Ed Seykota. He has run Tactical Investment Management since the early 1980's. Here are some of his nuggets of wisdom:

Having the freedom to switch direction - riding the bucking bronco

One of the skills an aspiring trend follower has to develop is being able to accept when he is wrong, and to switch directions if necessary. He attempts to ensure that his beliefs or opinions about what may (or may not) happen to a stock, index or instrument do not impact on his ability to follow the entry or exit signals presented to him.

Much ado about nothing

Well that's the first quarter wrapped up for 2016. And, as the metrics show, nothing much has happened in terms of performance. Looking at the monthly returns over the last year or so in particular, these losing months have been kept as small as possible. And, even after a period of non-performance, the returns on all closed trades is about 5R off of all time equity highs. Which, in the longer-term scheme of things, is nothing. One relatively decent trend will cover that.

As a comparison, below is a screenshot of the published monthly returns for Mark J Walsh & Co. While he was not one of the participants in the Turtles experiment from the 1980's, Walsh was an associate of Richard Dennis. You can view the monthly performance of other trend followers (including some of the former Turtles) here. 

The up and downs of a trend follower

Trend following has been proven over many decades, and by many of its practitioners, as an excellent methodology to make money in the markets. In terms of absolute returns, it may well be the best way to make money.

Yes, it is really does take only a few minutes a day

Edit: This post has been updated to reflect the use of the new watchlist scans, which identify potential set ups before they trigger. The old scans required you to watch the scans as they updated in real-time, otherwise you may miss an entry signal.

People that I give training to, who are new to trend following, are constantly surprised with the statement that I can spend less than 10 minutes a day trading the markets. The routine is very simple:

• By configuring my scans the way I want them, I can simply click a button and these give me an immediate list of potential stock candidates that meet the criteria programmed into the scan code;
• From there I go down the list generated, looking at the chart of each stock;
• Years of experience looking at the set ups that I know work means that I can tell within 5 seconds if a stock is of interest to me;
• If it is, one click of a button and its added to a watchlist - if it's not, I move on to the next one on the list. 

Once I've gone through all the scans (which cover longs and shorts, in different countries) I go to my trading platform, key in those stocks and look to see what the bid/ask spread is like, together with any restrictions on trading that stock. If the stock satisfies my criteria, I will either place an order at the market if it reaches my trigger price, or place an order to open at the desired level (as well as my initial stop) there and then. Job done.

As for my existing positions, I simply observe the charts and see if my stops need updating (they are only ever moved towards current price). Again, this takes a couple of minutes.

Then, in theory I could switch the trading platform off, and close the charts. With the watchlist scans you can go through these in the evenings, after themarkets have closed, and update your lists ahead of the next trading session. The scans update in real time, so you can do this as many times you want, but that is my preference.

Once the trainees in the mentoring programme who I meet have watched me go through the above, see what I look for, and how the charts and scans (as well as the system rules themselves) eliminate the need for a lot of  'interpretation', they begin to understand how I can spend so little time actually 'trading'. Over time, people can learn how to do the same - if I can do it, then so can anybody else.

If you have read Market Wizards, you will see a similar routine in Ed Seykota's interview (conducted over 20 years ago). He simply gets his end of day data, and places his orders ready for the next day. And then switches his PC off. Bill Dunn, profiled in Trend Following, has something similar, a single PC sounds an alarm when a signal is given - that's the only time his operation goes into the market. If you read the story of the Turtles, they spent most of the day reading the paper or playing table tennis.

For those who want to participate in the markets, and who may have other commitments or full-time employment, this sort of apporach is ideal. If however sitting in front of a PC for hours staring at charts, and wanting 'action' is your idea of trading, then trend following is not for you.

Guess what trend followers will now be doing...

The markets took me out of my last long position today in my standard portfolio, and all major indices are now on a short signal. In addition commodities such as gold, silver and crude oil are also on short signals. Therefore you can guarantee that the major trend followers will be acting on this information and going short these various markets. Depending on their system parameters some may already be in positions, some will be waiting for their entry points to be hit. As I've said before, the timing of the entries and exits may differ slightly, but trend followers en masse will make (as well as lose) money in the same time periods in the same markets.

Remember that also there are two basic types of trend following systems - the more popular style where you have differing parameters for entry and exit signals (such as what I use) which can mean that you can be on the sidelines at certain times, and there are also systems that are in the market 100% of the time (such as the system used by Bill Dunn of Dunn Capital Management, who was profiled in Michael Covel's book Trend Following).

No doubt a lot of people will be saying that the current drop is overdone, the markets are oversold and will rebound from here, etc, etc. All I know is that there will be trend followers, based all over the world, who will be following the price action, and if their systems say go short, they will be going short. And I, for one, do not want to be on the other side of their positions.

Be consistent in your approach

I posted the following on a bulletin board earlier this week which may strike a chord for some less successful traders, or those who hop from one system to another: