The Top 10 most read blog posts

It is amazing to me that, since starting this blog back in 2008, it has now received one million page hits.

The blog has morphed from initially being more of a diary of my own thoughts and my trading, to talking more about the general concepts involved in trend following.

While trading is one of the most popular keywords on any internet search, trend following is more of a niche area. To many, it is a marmite approach to the markets - you either love it or hate it.

The expectancy gap and performance leaks

When trading, you are free to construct your own methodology and set of rules to use - what markets to trade, triggers for entries and exits, how much equity to risk etc. That's the easy part.
 
For the majority of us, the difficult bit is ensuring you keep operating within that framework.

Building your own approach to the markets and the decisions and actions you take are entirely within your own control. But you have no control over what the markets do. Ideally, you want to react to the market's price movements, and trade within the confines of your carefully constructed framework.

On defining a trend, interpreting volatility and when to go fishing

Jesse Livermore aboard the Anita Venetian

"Your definition of trend is the smoothing method you use. The methods you use to define trend are entirely up to you, so you get to define trend any way you wish; everyone may have a different idea of "the" trend." - Ed Seykota.

Trend following, absolute returns and controlling open risk

At its core, trend following is an 'absolute returns' approach. You only have to look at the high-octane monthly performance generated by the Turtles back in the 1980's to see that. But to achieve that, you generally cannot impose too tight a control over the levels of volatility you have to endure. That is the other side of the coin.

Questioning some popularly-held beliefs

Stripping back our beliefs and subsequently our rules to their absolute basics, as trend followers, ideally we would want to be able to:

• generate an entry signal as early as possible into a new trend;
• exit a non-performing trade, if the new trend has failed, as soon as possible; and
• allow our position to run as far as possible on our chosen timeframe until that trend is invalidated.

Around those basic concepts people can follow pure price data or utilise technical analysis to 'formulate' their entry and exit rules.

As I've said before, I can be a bit of a trading heretic, and like to challenge some of the more popularly-held beliefs about how to trade successfully.

Below are a couple of those beliefs which I believe are worth further scrutiny - the use of multiple timeframe analysis and trend 'filters'.

Jesse Livermore, the Dow and the changing market state

Below we have the current daily chart of the Dow. This is a classic example of a 'tale of two market states'. Up to the beginning of February, we can see a stable (low volatility), trending state. And from the beginning of February to date, a volatile, non-trending state. This is highlighted by the rise in the readings of the volatility factor indicator and the 2ATR measurement.

Examples of opportunity loss

Suppose you have a situation where you take an entry signal only for the position to go nowhere, so you end up getting frustrated and close the trade. The next thing you know, the stock takes off in the direction you were attempting to trade, leaving you left on the sidelines. What have you lost? 

Some people would say that, as you haven't lost anything, you should simply move on and concentrate on what is happening in front of you now.

While I agree with the fact that you need to move on, I would  disagree with the point about not having lost anything - there is an opportunity loss incurred. 

Staying in my own circle of competence

Every so often someone contacts me to say they disagree with what I say and my beliefs, that some other successful trader they know of says the opposite to me, or simply to assure me that trend following doesn't work.

Well, I have news for you - and them.

I couldn't care less if your beliefs or methods are different to my own, which are rooted in those of people like Seykota, Dennis, Donchian, Parker, Hite, Livermore and others.

Some of my beliefs about backtesting

When it comes to trading, I like to think differently. I'm not afraid of being a bit of a heretic when it comes to thinking about the markets. While I adopt and use 'classical' trend following and breakout principles, I also like to think for myself, outside the box.

As an example, lots of traders swear by running backtests and tuning their trading models based on the results of their testing and analysis. Certainly, in some cases with getting to grips with a basic concept, backtesting can be of some use.

The rules of the game haven't changed

I started getting involved in trading back in 2003, and didn't get into trend following until 2006. As a result, I missed the huge trends (both up and down) from the dot.com bubble around the millennium.

While thinking idly back to those times, which are now getting on for 20 years ago (yikes!), I began pondering about how things have changed in the intervening period.

Back then, Facebook and Twitter didn't exist. The dot.com bubble sprang from something new to the masses called the internet. Mobile phones were nowhere near as common as they are today.

How on earth did we survive?

And that got me thinking, from a trading and historical viewpoint.

Do we even need charts?

In his book How I Made $2 Million in the Stock Market, Nicolas Darvas talked about how he created his own 'box' method of trading, based on simply recording the daily high, low and closing prices of stocks he was trading or interested in. This information was provided by telegram from his broker to wherever he was performing his dance act across the globe.

In How to Trade in Stocks, which he wrote shortly before his death in 1940, Jesse Livermore reproduced his own tabulated records which simply recorded price in the relevant columns denoting various price reaction points, whether the stock was in an upward or downward trend etc. From here he was able to identify the 'pivotal points' for each stock, which then helped him to commence his trading operations.

Dealing with profit erosion

Today was an interesting day. My one existing long position saw its profit evaporate after the release of a trading update, after which the stock fell just over 7%. However, this drop did not invalidate the trend, nor did it hit my stop. As a result I continue to hold the position. Of course, that may change tomorrow...

Trend following differences

I was asked the question last night about how I differ from other trend following traders.

The basic principles I (and many other trend followers) follow have been used by many successful traders going back decades - people like Ed Seykota, Jesse Livermore, Richard Dennis and the Turtle traders, as well as Richard Donchian, plus others. All have influenced my own approach to trend following.

Each had their own method of identifying when to get in and out of positions, their approach to risk, their chosen markets, their trade selection process etc.

What each trader does over time is evolve and refine their own approach, while keeping the same core concepts and beliefs as other trend followers. The differences come in how they implement those beliefs, along with the specifics of the parameters used.

What are your beliefs?

Part of your success as a trader will depends on what you believe to be important. As Van Tharp says "You trade your beliefs about the markets".

If you look at this list below, then I do not follow or use many commonly held beliefs out there:

• I don't study the fundamentals on a company - half the time I don't even know what these companies do;
• These days I don't even let the price action in the indices influence my trading decisions or market exposure;
• I don't track volume;
• Apparently trend following on stocks doesn't work;
• I take entry signals regardless of the time of day - whether it is in the first minute after the markets open or the last minute before they close;
• I take intra-day exit signals.

Beyond these beliefs, you can also look at the basic approaches or trading/investing concepts taken by successful traders. Go and read the Market Wizards series as an example and see the differing methods used by some of the most successful traders ever.

Jesse Livermore speaks

While most people tend to think of Reminiscences of a Stock Operator when Jesse Livermore is discussed, he actually wrote his own book How to Trade in Stocks shortly before his death in 1940. This is a treasure trove of wisdom that, in my opinion, every trader should read. While not all elements of his particular trading method may suit everyone, the basic principles he talks about are most certainly relevant, and have influenced my own trading:

Trend following, Jesse Livermore and natural disasters

This is not the easiest topic to write about, but with the happenings in the US this week I feel compelled to write about trading and natural disasters.

Those of you who have read Reminiscences of a Stock Operator, Edwin Lefevre’s classic book reportedly based on Jesse Livermore, will know that ‘Larry Livingston’(Livermore) profited from shorting stocks immediately prior to the 1906 San Francisco earthquake. Initially the market held up, but Livermore was patient enough to sit in his positions, and the market finally succumbed to a sharp downdraft after a couple days.

My own mentors

When I first started trading, it took me at least a couple of years before I found a trading strategy that I was truly comfortable with - namely, trend following. 

Initially I started out day trading high-beta US stocks, lured in (like many were) of the thought of making large amounts of money quickly. However I soon found that this did not suit me - I was often too slow to react to the entry/exit method I was using, and the commissions were swallowing up what profits I made. 

I therefore took the decision to fully research differing methods and timeframes.

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.