The joy of helping an aspiring trend follower

A while back I received an urgent message from one of the traders in my mentoring group. He managed to get himself into a trade where a trend had developed in his favour and was now (in his words) "going parabolic". 

This person had been developing his method over a period of time, so that it best meshed with his full-time job, which in a pre-COVID world demanded long hours and lots of transatlantic travel. As a result, his chosen timeframe and parameters are somewhat longer-term than my own, but the underlying principles remain exactly the same.

Donald Rumsfeld, Paul Tudor Jones, Facebook and Twitter

“I don't risk significant money in front of key reports, since that is gambling, not trading." - Paul Tudor Jones

When you are trading, the only elements you can control is when to enter a position, where you place your initial stop, your position size and the amount you are willing to risk.

Once you are in a trade, you have no influence over what will happen - the market (being other buyers and sellers) will determine future price direction, and consequently whether your position goes into profit or a loss.

You of course do have control over where you place your initial or trailing stop, but you do not always get out at those prices - particularly if you end up on the receiving end of a price shock and a resultant gap against you. As a result, there is always a risk that you can lose more than your initial risk on any trade.

Earnings releases are, in Rumsfeld-speak, a "known unknown". We know when they will occur, but we cannot predict or quantify their effect on price. Therefore, there is always potential downside risk attached to them. Some announcements may see price move in your favour, others can go against you.

This week we have seen two big-cap Nasdaq stocks suffer large price gaps following earnings releases. The charts of Facebook and Twitter are below.

From theory to practice - marching to your own beat

Yesterday I was asked an interesting question by an aspiring trader based in India who I have corresponded with for several months. I know he has eagerly been collating a lot of knowledge and information from a number of traders and resources over this period of time. Now he was basically asking me:

"How can I put all my trading knowledge into practice?"

The answer to this is a simple step-by-step process, which can be used by anyone in a similar position:

Some thoughts on position sizing

In my own trading, I use fixed fractional position sizing - that is, while the monetary value of risk per trade will vary as my equity goes up or down, I risk the same amount in percentage terms.

A trader friend of mine has implemented varying the percentage risk per trade based on a look back period of performance. 

Both methods have been used by successful traders and Market Wizards. Both have strengths and weaknesses.

Known unknowns and unknown unknowns

As traders, we have to accept that we do not know what is going to happen in the future. While our chosen method would look to to profit from an 'edge', based on some form of probability or odds (e.g. trends tend to persist until they don't), we should never approach the markets with an attitude that we can be sure what will happen from one minute to the next, one day to the next, or one week to the next.

Price action in an individual stock, forex pair or commodity can change behaviour at any time.

Therefore, we must account for that possibility in our own method, our mindset and our attitude towards risk.

Some thoughts on exploiting your edge

Traders who are successful over the long-term have clearly defined their 'edge' in the market or markets they trade. To me, an edge is basically a method that statistically generates a positive expectancy over a large sample of trades.

In order to capitalise on that edge, the trader needs to develop the ability to use that edge. This basically means that a trading plan which is constructed to exploit that edge is followed as closely as possible.

The starting point for any trader - what are your beliefs?

I've talked in the past about the importance of constructing your own trading method which is based around your beliefs.

But how do you start this process?

Taking action

Over the years, one thing I have found is that people are very good at talking about what they want to do. Following through and putting any plan into action is a different matter, though.

Stress testing yourself and your method - sowing the seeds of future success

These days, I always try to look at things from a positive point of view. Where others can only see the negatives or downside, I try to look for the potential upside or opportunities which may arise.

Attaining that mental state was not easy to achieve. In my early days as a trader, I struggled to keep my emotions and approach to risk under control - particularly when things went wrong. Things would get flung across the room, combined with a lot of negative talk and shouting, which can easily damage your self esteem. To change from a negative to a positive mindset took a lot of effort, but it has been crucial in helping me get to where I am today.

New testimonial

Over the bank holiday weekend I received the following testimonial from Mark:

“I have been in the Steve’s mentoring programme for just over 4 years. Quite simply: as a result of his fantastic mentorship my trading has completely evolved and ultimately become consistently profitable.

Regardless of the trend following method used, I have learnt the importance of psychology and risk control and that they are and will remain paramount to profitable trading.

Trend following and the ‘V’ shaped reversal

Occasionally when utilising a trend following method you have to deal with a ‘V’ shaped reversal. This is where, after moving strongly in your favour, price decides to sharply reverse direction, before your trailing stop has had chance to 'lock in' the bulk of those gains.

This type of price reversal can be the bane of a trend follower. I know my own basic approach struggles with them.

An example of a failed setup

I recently posted a potential long setup which appeared on the Dow (see here for more). With last week's price action, this setup has now been invalidated.

As we can see, price has started moving in the opposite direction to that I was looking to trade, coupled with a sharp jump in the 2ATR volatility measurement.

This type of setup failure has also occurred on a large number of long setups on individual stocks. While the setups originally identified may appeal and meet all my criteria, a lot of them never trigger an entry.

Discount offer on mentoring due to expire shortly

Just a short reminder that the current offer on mentoring expires at the end of the month.

Here are some testimonials from traders past and present who have been in our group, and who I've had the good fortune to help and assist.

If you would like any additional information please contact me at info@thetrendfollower.com.

One year on - have the changes worked?

"The great thing about being a trader is that you can always do a much better job. No matter how successful you are, you know how many times you screw up. Most people, in most careers, are busy trying to cover up their mistakes. As a trader, you are forced to confront your mistakes because the numbers don't lie." - Marty Schwartz

It is about a year since I start making some changes to my own trading approach. This followed a poor run of losing trades over several months which eroded most of the gains I had made in the first part of 2014. So, did those changes work?

Learning from past mistakes - and the markets

For those who have not traded through such a period in the markets before, you have been all geared up for an important educational experience over the three months or so. We have seen a big jump in volatility, combined with a sharp move to the downside followed by a 'V' shaped reversal in the general markets. Ideally, when experiencing these changes in the market state you want to keep your tuition fees as low as possible.

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.

I love taking losses - do you?

I was reading another trend following blog the other day when I saw a comment along the lines of "as a trader, you will never be happy taking losses".

Two examples of fear and greed

Below are a couple of examples of trading issues I've encountered relating to fear and greed. These are typical of people struggling to getting past the break-even stage of their own trading. As with all issues, identifying them and putting a suitable plan to eliminate them will help accelerate your progress.

The source of your profits

Occasionally I come across traders who seem to take great delight in criticising or rubbishing certain elements of another trader’s approach to the markets or their trading rules, which may have formed an important part of that trader's success over a long period of time.

It is very difficult to critique anyone else's general approach or a specific rule they use, unless you know their complete trading plan, their attitude to risk, their beliefs and mindset, as well as their performance.

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.