Part 1: Introduction
Trend following is devastatingly simple. Markets trend: they move up or down or sideways. People have profited handsomely in the past from the following simple techniques:
- Go long as markets trend up.
- Go short as markets trend down.
- Exit when trends reverse.
- Let your profits run.
- Cut your losses short.
- Trade small in relation to your capital base.
- Stick to your system.
- Ignore talking heads and day-to-day news.
You don’t need systems costing thousands of dollars with exotic names to follow trends. What you do need is:
- A reliable source of clean end-of-day data.
- A good back-testing engine.
- Propitious markets.
Markets have been very unkind to the trend following strategy for the past two or three years because successful trend following requires trends. If that sounds simplistic it is nonetheless true. I have heard countless people over the past two or three years saying this or that market has been rising or falling rapidly, so why are trend followers losing money?
The answer is very simple: there have not been enough recent trends of a sufficient duration and magnitude to make up for the many losses caused by trades which have gone nowhere. If most markets are trading sideways, choppy and keep changing direction then trend followers endlessly enter and exit the market at a loss on each occasion.
Will this change? I don’t know for sure, but I will give you my opinion. I expect trend following to conditions to improve. I expect to be able to make money for myself out of this strategy in the future.
I will also give you a warning: I do not believe that trend following profits will come as easily in the future as they have done in the past. The vast number of new entrants into the strategy over the past few decades has undoubtedly changed the markets. Markets trend less smoothly, they are more volatile, trends are less efficient, and it is a great deal easier to get chopped in and out at a loss these days. See my many posts at Traders Place for more on the topic:
- Where are the Trends?
- Declining Trend Trade Length Responsible for Recent Losses?
- Trend Following: Reality or an Illusion doomed to Failure?
- Trend Efficiency Index
- Do Markets Change? Trend Following
Let me give you an outline of topics I intend to cover in my posts about trend following over the coming weeks and months:
- Instruments to trade
- Portfolio construction
- The reality of trading short
- Entry and exit rules
- Position sizing and money management
- Managing leverage and risk
- Profit taking
- Back testing software
- Strategy system and design
- Example strategies you can trade or adapt
- Markets change
- Psychology and risk
- What to do next
I may well add a few more topics as I go along.
By then end of this series of blogs I believe you will be in a good position to begin trying out trend following for yourselves. After many months of thought, coding and back testing you should then be ready to place a cautious foot in the markets – but only if you believe the strategy will continue to be a successful one and that you have what it takes to make it work for you.
Many are called and few are chosen!