10 questions on Trend Following

Recently Michael Covel answered 5 questions almost every
trader asks about Trend Following (to read this article

click here
). This week, Michael delves even deeper into the subject.

Ashton Dorkins


Q: Any comments about the market we are seeing now?

A: No. Trying to look at some one month, 6 month or year period as a trend follower is pointless. Trying to examine the market from a short-term time frame is trying to make the market make money when you want it to. It doesn’t work that way. You have to take what the market gives you. Markets go up, down, and sideways. They trend. They flow. They surprise. No one can forecast a trend’s beginning or end until it becomes a matter of record, just like the weather. However, if your trading strategy is designed to adapt to change, you can take advantage of the changes to make money.

Q: How did you view the markets before trend following trading?

A: Like most everyone, I was exposed to fundamentals first. I remember all of my college professors saying it was impossible to make money from the markets. When you are young if you don’t know better – you believe them – until you learn better and learn how wrong they were.

Q: What makes a good trend follower?

A: This answer is best answered by my book “Trend Following”. The book gives me a chance to answer this question in the detail needed. In simplistic terms, a good trend follower has a trading system with rules and the emotional/psychological temperament to stick with his trading system rules. Life is about choices. You can’t be a trend follower and base your decisions on fundamental analysis or Elliott Wave or some other Holy Grail trading technique. The great trend followers trade objective methods. Where are the great Elliott Wave traders? Where are their performance numbers? Or when you say you use fundamentals such as interest rates or economic growth forecasts what do you mean exactly? Think about it this way: Losing traders forecast where the market will be tomorrow. Winning traders, like trend followers, react to what the market is doing right now.

Q: One of the most difficult things for many traders who have actually be able to capture a trend is to stay with it. How do you know when to get out?

A: You need rules. You need to know when you will get out before you ever get in. If the rule is to enter on X day breakout, then perhaps the rule is to exit on X day breakout in the opposite direction of entry. Trend followers never time the top and never get out before the top. Trend followers always exit after the peak on the way down (or way up if you had been short).

Q: How do you handle sideways markets?

A: Trend followers lose money in sideways markets. No trend means no trend following. You handle sideways markets by cutting losses short. You handle them by knowing they are possible and knowing they will happen. Sideways markets are all about having great risk management.

Q: How do you manage your risk?

A: You have to find that balance of reward and drawdown comfortable for you. Risk management is counterintuitive for most folks. Most want to pretend that you can enter the market and never have losses. If you look at the track record of a great trend-follower like John Henry, Bill Dunn or Mark Rosenberg, and you look at two decades of their monthly performance, you’re going to see as many down months as up months. Most people just want to believe it’s always going to be up. Even when something like the dotcom bubble happens – and the Nasdaq is still down 60% – they want to imagine that it’s not really happening. Trend-followers accept that losses are happening. They know it is part of the game and they have a plan to deal with them.

Q: How do you determine when you are wrong in a trade?

A: The price will tell you. If you get in at 100 and market goes to 75, you are wrong.

Q: As far as executing trades is concerned, is that a subjective process or do you that mechanically?

A: Trend following is about rules. It’s about putting those rules into a form that you can objectively follow. Subjective entry/exit rules or subjective money management rules would defeat the purpose.

Q: What do you find most frustrating with trading?

A: That so many people don’t get “it”. That so many people are seduced into wrong behaviors trying to get rich quick.

Q: What do think is the difference successful traders and unsuccessful traders?

A: Will. For most people quitting is far easier. In fact much research today shows people are more comfortable staying with what they have than exerting the extra effort to break out to new heights of 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.