How do you define a trend?

The past has happened. The future doesn't exist.

Therefore, we can only react and respond to what is happening in the moment of now.

So, for traders the question is, what is price doing now?

The tricky bit is how you define "what is price doing now".

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.

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'.

Recency bias, and labelling markets as easy or hard

I've seen it said that one of the goals you should have as a trader is to try and make money when things are easy, and that you should be more defensive and protect what you have when things are hard.

That is all very laudable, but from a trend follower's perspective there is a problem with that.

Trading the line of least resistance

A lot of the people who were profitable in 2008 became unstuck the following year. They seemed to get in their head that, once the markets started rallying, they were anticipating a further, more pronounced price drop.

In the summer of 2009, they got their chance. There were numerous trading blogs of the day talking about a 'head and shoulders' pattern which had formed on the indices between May and June, and they were going to use this as a trigger to go short the market, and really make a killing.

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.

Keep your eyes open for stocks bucking the trend

As a breakout trader, I only ever go long on new highs, or go short on new lows. Therefore, while the longer-term trend in the general market is still intact, the recent pullback or consolidation (not only in the major market averages, but more importantly in lots of individual stocks), in theory makes it difficult for me to participate.

One of the reason I am continuing to run through my scans and keeping my watchlists up to date is that you may find individual stocks that are bucking the trend, so to speak. 

Some random charts

It's been a while since I have posted some random charts, but here goes:

It is interesting to note the pattern currently developing in the German DAX. You can clearly see the 'staircase' of higher and higher lows in place from early December last year before price stopped moving up in June.

What you can learn from Seve Ballesteros

Ballesteros on the 12th tee, Augusta 1980

In 1980 Severiano Ballesteros won his first US Masters by 4 shots. At one point in the final round he was a mammoth 10 strokes clear of the field. If some people thought his win in the Open Championship the previous year was a fluke, this announced his arrival as a world star.

In his book Natural Golf, Ballesteros talked about the aftermath of that success and how it actually had a detrimental effect on his game for a time:

Traders, their beliefs and opinions, and what you can learn from Eckhart Tolle

"Accept, then act. Whatever the present moment contains, accept as if you had chosen it. Always work with it, not against it." - Eckhart Tolle

Every moment in the market is unique. Price can move in either direction in the next few seconds, the next few hours, the next few days, weeks or months. Despite what some people may say, you don't know what will happen. Price may be trending one direction on one particular timeframe, and could be trending in the opposite direction on a different timeframe. 

How you interpret what price is doing, and how reactive you are to any changes in price behaviour, will depend initially on those core beliefs you have about trading, and from there your own rules derived from those beliefs.

Adding some accountability to your trading - helping a day trader to improve

A while back I was approached by a day trader who wanted some help in improving his performance. This took me back a bit - as readers of this blog may know, when I started trading back in 2003 it was as a day trader (and I initially struggled) before I got into trend following.

I've long believed that the essentials of good risk management and being able to avoid mental errors are applicable to ALL types and styles of trading. This would therefore be an interesting exercise - for both of us.

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. 

Longevity is the key to success

For a trend follower, the lack of decent trends over the last couple of years or so in the stock markets was perhaps expected - 2008 on the downside, followed by 2009 and 2010 on the upside were fertile periods to profit from price trends. 2011 was a difficult year for me, whereas 2012 and 2013 offered favourable conditions.

Slave to the system

Whenever a trend follower captures a big winning trade, outsiders often wonder if it down to pure luck, skill or something else?

In a lot of cases, trends can start to develop in spite of the current sentiment and beliefs of many of the market participants.

Trend followers however approach the markets in a unemotional state - if their method tells them to enter a trade at a certain price level, they enter. Similarly, if their method tells them to exit at a certain price level, they exit.

Not 'jumping off' the ride, and letting trades play themselves out

A trend follower never takes positions based on predictions or opinions about what may happen. Trend following is reactionary, and based on what price is doing - therefore price has to show some strength before you look to go long, or some weakness before you look to go short.

Just as importantly, trend followers never try and predict potential turning points in a market. There is a process where price can look to change trend from one direction to another - this can happen very quickly, or in some cases take several months! Generally speaking though, this takes time, and a single day's movement does not constitute a change of trend.

It is for this reason that trend followers never get out of an existing position at the extreme of the move. There is always a process of 'giving back' some of the open profits before an exit signal is triggered, and/or a change of trend is signalled.

I'm just following orders...

Every approach to trading has its own strengths and weaknesses, and often these show themselves when the inherent market direction or conditions (trending or non-trending, stable or volatile) change.

In its purest form, trend following is a reactionary process. You go long when price has started to show strength and made new highs, and go short on weaknesses, and made new lows. Therefore, when markets get choppy, you can suffer small loss after small loss. However, you can also cotton onto new trends far earlier than a lot of other market participants do...

Combining technicals and fundamentals for investing

Recently I had the opportunity to review an investor’s portfolio. This was valued in excess of £1m. The allocation of the funds was entrusted to a well known brokerage. I was asked for my opinion on the performance and allocation of the fund.

What I learned from two Market Wizards about volatility

Given that the markets have taken off to the downside so far in 2016, readers may be wondering why I have not taken any positions so far this year.

Is this price action different?

My guess is that there are plenty of people trading now who didn't participate in the markets in 2008. Since the market bottomed out in March 2009, there has been a long uptrend, although the major averages have certainly struggled to make new highs in recent times.