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.

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.

Focus on your own trading and the trends you are looking to profit from

We know that markets can move from a trending to non-trending state, or vice versa, at any time. But as Ed Seykota says, there is no such thing as 'the' trend. 

Also, different traders will have different interpretations about the type of trend they are looking for - one person's long-term trend may be another person's short-term trend.

The important point here is that how anyone else defines a trend is irrelevant to your own trading and performance.

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'.

Volatility issues

Below I have shown a chart of the Dow which highlights the split personality of the markets in recent times.

Up until the end of January, we can see the market clearly in a trending, stable (i.e. low volatility) state. From there, the chart is a mess, and the Volatility Factor and 2ATR measurements clearly show the explosion in volatility.