Trend Following: Confusion across the board
Trend following trading by now should be a straightforward concept to grasp. However, I see confusion about the subject regularly. Below you will find an assortment of examples that help to paint a clear picture of what it is and what it is not.
Shorter-Term Trends Confusion
Here is some recent feedback on “shorter-term” trends that arrived in email:
“Michael: I have read the older version of Trend Following and am working to apply the knowledge you conveyed so well in it. I am a definite believer in trend following and its benefits. With that being said, I would like to offer one piece of ‘information’ that I have acquired through reading a couple of dozens books on trading and my somewhat limited experience trading. For some reason, perhaps that I am 55 and my brain isn’t as fast as it used to be, I came away from reading your book with the following phrase in my mind: “Long-term trend following.” Admittedly, your book does not really use this phrase. You simply recommend ‘trend following.’ The reason I raise this issue is that, trend following does not, by definition, have a specific time frame inherent with in its’ ‘methodology.’ It does not have a defined length, or even an intoned length of trade. My mistake in interpreting ‘trend following’ as ‘long-term trend following’ caused me to stay in trades after a seemingly ‘short-term trend’ (meaning less than a few months) had run its course. Because I had the concept of ‘long-term trend following” in my mind, I was looking/expecting trades to last for many months and perhaps into years. While there are trends that will meet these criteria, there are many, profitable, ‘trend-following’ trades that last only a few days or a few weeks depending upon the future/stock that is being traded. Once I recognized this ‘long-term’ definition error in my thinking, I have been exiting some ‘trend-following’ trades more quickly than before, and have, as a result, often ‘saved’ substantial profit that I was previously letting slip away while I waited for the ‘long-term’ time period to pass. I share this with the hope that it might help others who might suffer from the same misconception that ‘trend following’ has some pre-defined aspect of time built into it. It doesn’t.”
How do you determine the “time period for which one’s analysis applies”? The trend followers that I have written about and the trend following I describe is thought of as long-term trend following. That’s how they define themselves and their trading. There are the few super traders (i.e., Simons, Crabel) who can trade very short time frame trends with success, but the average trader has no shot in my opinion in so-called “shorter trends”. Shorter trends require much more in terms of execution and commission for success.
After reading that exchange another reader writes:
“Wanted to add a comment to (blog] on shorter trends. I can relate. In my opinion, and with 7+ years experience, I believe what constitutes “a trend” is much like beauty, it’s in the eye of the beholder. It is very subjective. Certainly Dunn, Henry and others perceive “trends” in markets with a longer-term perspective than perhaps others. I, for instance, perceive markets in terms of “trends” that generally last from several days to several weeks. While I may trade a particular market 12 to 15 times in a year, the LT trend followers may only trade it once of twice.”
Short term trading is doable, but you better be Jim Simons or Toby Crabel. And you better figure out how to handle commissions and execution costs that will always be there to eat away profit. I add a brief new comment on this in the new edition of Trend Following in the appendix.
Moving Averages Confusion
Feedback recently received regarding moving averages:
“Hi, I was just experimenting using different moving averages to react to price movement in equities and futures. I notice that in your book, you mention only exponential moving averages of different time lengths. What do you think of using moving averages with different calculation methods (say exponential and triangular or time series) in order to track recent price movement in a stock as opposed to price movement in the past? It seems like that would be a pretty good way to track breakouts. Thanks. Joe.”
I look at these issues in a different way. The key is answer the 5 questions presented in Chapter 10 of my book:
1. How do you determine what market to buy or sell at any time?
2. How much of a market should you buy or sell at any time?
3. How do you determine when you enter a market?
4. How do you determine when you exit a losing position?
5. How do you determine when you exit a winning position?
If after testing you determine that your variation or choice of moving average works to help you answer those 5 questions (to meet your personal goals of profitability, drawdown, etc.), then you are on to something. If it doesn’t work, lesson there too. But don’t get fixated on the entry indicator…as your Holy Grail.
Rising Markets Confusion
A reader sent me feedback on “gold” and rising markets:
“The question that everyone seems obsessed with is, “Why is gold rising when the dollar is also near a high and inflation is tame?” The answers given by financial pundits in the mainstream press are varied and no one agrees what the true answer is. A recent article in the Washington Post seemed to hit the nail on the head: “Gold’s New Luster Puzzles Traders.” Might I suggest that the proper response (from an investor’s standpoint) to this question is as simple as it is straight-forward: Who cares?”
Trend Following Book Confusion
Feedback recently posted about the book “Trend Following”:
“This book is another pie-in-the-sky book. Technical analysis is not the end all to investing in markets. Sure, the author has empirical data but…so what. He fails to mention the enormous DD’s one has to endure in order to make money. It is proven that mechanical trading systems do not hold their weight in gold. By and by, they become obosolete
(sic] because…they were curtailed to a selective time frame that no longer supports their viability in the wake of present time. Relying solely on mechanical trading systems that are derivatives of technical analysis is futile to longevity investing in the markets unless you have a lot of money you can use to weather the storm with. This strategy is best suitable for CTA’s and hedge funds…people who have the money to put up and stay in the game with…if the situation gets kind of murky.”
My comments for this reader:
1. Read p. 6-10 of the book Trend Following.
2. Read p. 246 of the book Trend Following.
3. The Nasdaq is in a 55% drawdown spanning 5.5 years. Drawdowns are the brutal reality of making money.
4. I wonder where it is proven “that mechanical trading systems do not hold their weight in gold?” What does that mean exactly?
5. I wonder what “By and by, they become obosolete (sic) because…they were curtailed to a selective time frame that no longer supports their viablilty in the wake of present time” actually means?
In terms of trend following becoming obsolete, that cry has been screamed by skeptics for over 30 years. I know some very wealthy trend followers who must wake up every day dreading their “obsolescence”!
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.