5 questions every trader is asking
Q1: Trend followers must
be doing well in this market; how long will it last?
How long will what last? Trend following as a
viable trading style? There is no reason trend following should stop. If markets
were to go sideways forever, there would be no trends and then trend following
would cease to work.
Trend Following goes against all the customs, rituals, trappings, and myths we
have grown accustomed to associating with Wall Street trading success. Trend
following traders respond to what is happening in the market rather than
anticipating what will happen. And they base their trading decisions on one
piece of core information: The market price. That makes them different from the
vast majority of traders and investors who rely on fundamental data to make
their trading decisions. They think the only way to beat the market is to gather
all of the information you can find. They want news, they want CNBC, they want
The Wall Street Journal, they want crop reports, they want OPEC rumors, they
want Greenspan’s shoe size – they believe all of this extraneous information
will help them to make profitable trading decisions. And when they make a
decision, 99 times out of a 100 it is to buy and hold, hoping that the market
will go one way if they just hang in there. Hope is not a good trading strategy!
Trend followers, on the other hand, who are technical traders by nature, say
enough! The market price is the best source of information about the market
direction because the market price is the aggregate vote of everyone. It doesn’t
matter if the market goes up or down because all you care about is the price.
All markets, from stocks and bonds to metals, currencies and commodities can be
traded the same because all you need to know is the market price. Trend
Followers see the world in trends. Trend followers know that trends will arrive
in unpredictable ways going either up or down. Trend followers simply want to be
on board to ride those unpredictable trends for profit. Think about it – what
else can you really believe in beside the market price? Or, to quote John W.
Henry, “The greatest action, the wisest, the best action that you can take in
almost any situation is to stay with what is, instead of jumping to conclusions
or trying to come up with conclusions. Just pay attention to what is.”
Q2: Most new traders hear
the “trend is your friend” speech early, but the majority of them never
last more than six months. Is trend following really so difficult?
I think most people fail in entrepreneurial
ventures, including trend following trading, due to a lack of will and lack of
patience. Is trend following difficult? Conceptually, no it is not. But if you
can’t stick with it, it will be difficult. However, what in life that results in
great reward is easy? The harsh reality of today’s markets is no different from
yesterday or 10 years ago. Whether you are a trader or investor, ultimately you
have only yourself to blame for the decisions you make regarding your money. You
can make winning decisions or losing decisions – it’s up to you.
If you’re a trend follower, you make your decisions based on the market price.
If the trend is up, it’s a buying opportunity. If the trend is down, it’s a
selling opportunity or a time to go short opportunity. The market is a brutal
place and you must be prepared for ups and downs in your account, including
drawdowns and recoveries. You never bet against the trend. Sound hard? Well,
great trading is hard!
Q3: Explain some of your
market concepts and trading ideas.
So many people get into arcane technical
analysis. The great traders don’t do that, and neither do I. Trading – the way
you enter and exit a market – could really be anything. The trend-followers I
write about in my book have a fairly specific strategy. First, they select a
portfolio and the markets they’re going to track. Then they wait to see if a
market starts to move. And if it does, either up or down, then a trend-follower
will take an initial long or short position, depending on the direction of the
market. The age-old market wisdom is that you’re going to run with that position
for as long as it goes in your favor. You’re not going to guess, or predict, or
forecast the direction. You don’t know why the market is going up. And frankly,
I haven’t met a great trend-follower yet who really cares why the market’s
moving. He just says, “My #1 goal is to get on these moving markets and have
risk management so I know that if the market goes against me, I know where and
when to exit.” That frame of thinking might be the big difference. Trend
traders always know what their loss point is. They don’t know what the upside is
going to be, but they know what the downside is. They’re risk managers.
Q4: What are the essential
qualities of a new forming trend?
I keep getting asked that question. I think it’s
phrased incorrectly, because what you’re really looking for is more like
wildcatting for oil. You drill a bunch of oil wells, and seven out of 10 of them
are going to be failures, but three of them will be gushers. The idea is not
really about picking or measuring a trend, it’s to know the markets that you’re
following, and know when you’re going to enter and exit.
A good example of entry is the age-old break-out. You’re looking for a market
that has momentum, or a market that’s moving up or down. When you find it,
you’re going to get in. But when do you want to get out? Trend-followers never
get in at the exact bottom if they’re going long, and they’ll never get out at
the exact top. A typical trend-follower will get in late and get out after the
market has peaked. He rides that trend straight up and doesn’t know he’s going
to get out until it’s going the other way. That’s the confirming signal to a
trend-follower. He’s not trying to fight the process, or over think it or over
rationalize it. The trend-follower just says, “If it’s going up, I’m long. And
when it starts to go down, I’m getting out. Perhaps I’ll go short.” Even more
specifically, strong breakouts to new highs or lows. Don’t make it much more
complicated than that. And of course, a breakout alone does not mean the trend
will continue. You can never know you have had a great trend until it is over.
Q5: Where does the
psychological element come into play?
It’s not the genius of a trend following system
that makes them wealthy. It’s their self-discipline, willingness to be
responsible for what they do, and their hard work. Trend Following rules are the
easy part. It’s playing by them that is so difficult for many. Frankly it all
comes down to defining what you really want. Most people don’t want to become
rich, they just want to be rich. That’s no definition. That’s a dream. To become
anything you need entrepreneurial zeal, you need passion. But I believe there
are a number of key determinants:
– Lack of discipline: Traders are often lazy when
it comes to the education needed to trade successfully.
– Impatience: Traders often have an insatiable need for action.
– No objectivity: Traders tend not to cut our losses fast enough. We marry our
positions.
– Greed: Traders often want quick profits.
– Refusal to accept the truth: Traders often do not want to believe that the
only truth is price.
– Impulsive behavior: Traders often jump into the markets based on a story in
the morning paper or on MSNBC.
– Inability to stay in the present: Traders often spend time thinking about how
they are going to spend their profits or regretting mistakes they made in the
past.
– Avoiding false parallels: Traders often look for patterns from the past that
will enable them to predict what will happen in the future.
The quote by Carl Sagan, “It is far better to
grasp the universe as it really is than to persist in the delusion, however
satisfying and reassuring“, is a great reminder of what it takes for trend
following success.
Michael W. Covel is the founder and
President of Trend
Following. A researcher of the most successful Trend Following investment
managers, he has been in the alternative investments industry consulting on
Trend Following to individual traders, hedge funds and banks for ten years. His
best selling book,
Trend Following: How Great Traders Make Millions in Up or Down Markets, New
Expanded Edition (Prentice Hall, November 2005) is a complete and concise
guide to trend following. It includes interviews with great trend followers who
have won millions if not billions in the market. The trading world has embraced
the book with endorsements from Van K. Tharp, John Mauldin, Ed Seykota and many
more. Trend Following is now in its fifth printing, and is currently available
in a Japanese translation with Chinese, German, French, Korean and Russian
translations soon to follow. Teaching and sharing unique insights about Trend
Following trading and alternative investments has earned Mr. Covel respect as a
rational and logical voice in uncertain times. Mr. Covel also writes for
numerous industry publications including Your Trading Edge, Stocks, Futures and
Options Magazine and International Petroleum Finance and is consistently quoted
and interviewed by a variety of financial publications.
Mr. Covel is also Managing Editor at
TurtleTrader.com, the
leading Trend Following news and commentary resource since 1996. Thousands of
visitors from more than 70 countries as well as hundreds of trading
professionals engaged in years of debate and interchange making the site the
rich archive of trading information, data and opinion that it continues to be
today. TurtleTrader, one of the largest & strongest trading community on the web
with over 7.5 million unique visitors since its inception, also functions as a
resource center for the Trend Following Educational Course.