TrendFollowing101

Aconciseguidetotradinglongandshort

CopyrightJBMarwood2014/2015

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DISCLAIMER

Thisbookisaneducationaldocumentandissoldwiththeunderstandingthatneithertheauthororpublisherwillacceptanyresponsibilityforlossesorriskasadirectorindirectresultofusingideas,applicationsortradingsystemsdescribedinthisbook.Tradingsystemsare

presentedinafairandaccuratewaybutmaybenefitfromextratestingandfurthercustomisation.Tradinginfinancialinstruments(suchasequities,fixedincome,foreign

exchange,futures,options,CFDsandallothertypesofexchangetradedoroverthecounterfinancialinstruments)carriesahighdegreeofriskandisonlysuitableforinvestorswhoareabletosustainsubstantiallosses.Inthecaseofmargintrading(suchasfutures,options,CFDsorleveragedequitytradingforinstance),theriskoflosscouldbegreaterthanthe

amounttheinvestorhasinitiallydepositedintohis/heraccount.

Formoretradingideas,systemsandstrategiesvisit:

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CONTENTS

IntroductionPriceiskingNotjusttechnicalanalysisSearchingforthelongtailTrendfollowingbasicsHowtofindatrendMovingaveragesBreakoutsOtherapproachesManagingriskStopsornotRisk:RewardTrendtradingsystemsCurvefittingandotherbiasesDoestrendfollowingworkonstocks?FamoustrendfollowersWhathappenedin2008?Istrendfollowingdead?Whatdotrendfollowerssay?ConclusionAppendix1.MovingAverageStrategyAppendix2.29rulesfortrendfollowingonstocksAppendix3.TrendFollowingForStocks:CompleteTradingSystem

Wikipedia:Trendfollowingisaninvestmentstrategybasedonthetechnicalanalysisofmarketprices,ratherthanonthefundamentalstrengthsofthecompaniesorsecurities.

Introduction

Ifyoulookataselectionofcharts,itquicklybecomesobviousthatpricestendtomovein

particulardirectionseitherupwardordownwardforextendedperiodsoftime.Often,there

maybenoobviousfundamentalreasonwhythisisoccurringbutitis.Thesearetrendsand

successfultradersgeneratesignificantprofitsbyidentifyingandfollowingthem.

AccordingtotheWikipediadefinitionabove,trendfollowingisbasedontechnicalanalysis.In

reality,Iwouldsaythatthisisonlypartlytrue.

Technicalanalysiscanincludeanynumberofdifferenttechnicalindicatorsandstrategies,

manyofwhichhaveverylittlevalue.Trendfollowingontheotherhandismorephilosophical

thanasimpletechnicalanalysisapproach.

Itisthebeliefthattrendsexistacrossnumerousmarketsandindustriesandevenmore,that

thereisareasonforthemexisting.Itisthebeliefthatthepriceofasecurityisthemost

importantthingtounderstandandeverythingyouneedtoknowaboutamarketcanbe

ascertainedfromitspriceaction.

Itisalsothebeliefthattrendscanlastformuchlongerperiodsthanexpectedandtrend

followingistheapproachdesignedtocapturethelongtailofmarketreturns.

Recentmediacoverageoftrendfollowinginsiststhattheapproachisoutofdateandsome

commentatorshaveevenproclaimedthattrendfollowingisdead.Iwillcometothislateron.

Fornow,letstakealookatwhattrendfollowingisandwhatitisnt.

Priceisking

Investorsusetechnicalanalysistoidentifytrends,todeterminewhentoenterthemarket,and

toformulatetheirexitstrategy.However,thisanalysisisreallytargetedattryingtoanticipate

pricemovementsandpriceistheoverridingprinciplebehindtrendfollowing.

Thekeytenetoftrendanalysisandthemantraoftrendfollowersisthatpricecantell

investorseverythingthatisimportantaboutasecurity.Ittellsthemhowthestockhas

performedinthepast,whereitisnow,andwhatthefutureislikelytoholdforit.

PerformanceofafamoustrendfollowingfundrunbyBillDunn.Src:DUNNCapitalManagement.

Becauseofthis,trendfollowersfocusonpricemovements,ratherthantryingtouse

fundamentalfactorssuchaseconomicdata,geopoliticaleventsandothermacroeconomic

factorstopredictperformance.Inessence,theybelievethatthemarketisalwaysrightand

thatprofitscomefromfollowingwhatthemarketisdoingatthatprecisemomentratherthan

tryingtopredictwhatwillhappennext.

Ifyouconsideralltheinputsandinformationthatexistinthefinancialmarketsyouwillrealise

thatattemptingtounderstandwhatcausesamarkettomoveinacertainwayisnear

impossible.

Forexample,canyoureasonablyexpecttoknowalltheinformationaboutaparticular

companysfinances?Canyouevenbegintounderstandtherelationshipsthatgointothe

supplyanddemandconstraintsofaparticularcommodity?

Trendfollowersarguethatattemptingtoanalysefundamentalsisfutile.Everythingthatyou

needtoknowaboutamarketitreflectedinitsprice.Thepriceisallyouneedtoknowanda

marketthatisgoingupshouldbebought,whileamarketthatisgoingdownshouldbesold.

Notjusttechnicalanalysis

Sometrendfollowersclaimthatwhattheyaredoingisnotjusttechnicalanalysis.Theypoint

totheexistenceoftrendsacrossmanysphereseconomic,political,fashion,technological

toarguethattrendsexistacrossallareas.

Thisisareasonableclaim,butitisworthwhiletorememberthattrendsarealsotiedtounique

marketphenomena.

Forexample,investorenthusiasmcandrivetrendstoextremeswithoutanyfundamental

underpinningintheendthiscanmakethemsusceptibletopainfulreversalsbutthetrend

followerwillusuallyhavemademanyhundredsofpercentalongtheway.

Thedot.comboomisagoodexampleofthis,buttherearemanymorerepresentativecases

throughouthistory,includingtheDutchTulipManiainthe17thcentury,andtheSouthSea

Bubbleinthe1800s.

Therearealsoshorttermfactorsatplay,suchaswhenthemarketbecomesoverboughtor

oversoldwhichcanleadtoatrendstallingorevenreversing.Thissortofshortterm

technicalphenomenonreallyhasnoexactcorollaryinotherareasoutsideofthemarkets.

Searchingforthelongtail

Backin1909,HenryFordmadethestatementthatAnycustomercanhaveacarpaintedany

colourthathewantssolongasitisblack.ThiswasinreferencetotheModelT,thecarthat

madeFordapowerhouseintheautomotiveindustry.Thisisaperfectexampleofmass

marketing,whichtargetsthevastmajorityofconsumerswithaverynarrowproductoffering.

Infact,thisiscapturedinthe80/20ruleorParetoprinciplewhichassertsthat80%of

casescanbeaddressedbycovering20%ofthetotalsetofrequirements.Thisisa

characteristicofmanymathematicaldistributions,whichseethevastmajorityofitems

clusteredcloselytogetherwithonlyafewoutliers.

However,thisprincipledoesntalwaysholdparticularlyincaseswherethereisalongtail

distribution.Thisiswhenadisproportionatelyhighnumberofcaseslieoutsideofthecentral

peakofthedistribution.

Thisdistributioncanbeseeninmanyareassuchasrecenttrendstowardsmass

personalization,aswellasthesuccessofcompaniessuchasAmazon,whichtargetthelong

tailwithahugearrayofproducts,ratherthansellingafewproductstoamassmarket.

Infact,inalongtaildistribution,lessthan50%ofcasesfallintothatcore20%of

requirements,makingchasingthelongtailhighlyprofitableformanybusinesses.

Thesamelongtailprincipleappliesforinvestorswhofollowtrends.Longtailsare

characteristicoffinancialmarketsforexample,ifyoulookatabroadselectionofstock

returns,youllfindthatsomeofthemmoverelativelylittleoverayearmaybe5%or10%

buttherearealsoadisproportionatelyhighnumberofstocksthatmakemuchlargerprice

moves50%,100%,200%orevenmoreinsomecases.Thesearethelongtailstocksthat

trendfollowersarehunting,sincetheyofferthebiggestopportunityforprofits.

Trendfollowingbasics

Becausetrendfollowersaretryingtocatchthelongtail,theytypicallyadoptarelatively

straightforwardstrategy.Theybuywhenthemarketisrising,andsellwhenitsonitsway

down.Whattheyhopeisthattheyaregettinginonthestartofatrend,whichtheythenrideto

itsprofitableconclusion.Theydontactuallycarewhetherthemarketisrisingorfallingthey

areunbiasedandcanmakeprofitsinbothcases.

However,becauseofthelongtailnatureofthemarket,someofthesetrendswillbe

shortlivedorevennonexistent.Itsabitlikewavesatseatherearetinyripples,some

biggerwavesandtheoccasionalmonster.Thebigwavesandthemonstersarewheretrend

followersmaketheirprofitsbut,theyalsofindthemselvestryingtoridetheripples.Worse

still,theyfindthatthewaveismovinginthewrongdirectiontheyexpecttobeliftedup,but

theyfindthemselvesfallingofftheotherside.

Becauseofthis,trendfollowersnotonlyneedtojumponwavesthatlookhopefulinother

words,arisingorfallingstocktheyalsoneedtobepreparedforwhenthingsgowrong.

Whiletheyneedtoridethewinnerstotheirconclusion,theyalsoneedtogetoutquicklyand

cuttheirlossesonlosingtrades.Iftheydidntdothis,thelosseswouldoverwhelmthewins,

leadingtoaninevitableandcostlyresult.Inotherwords,thegoalistohaveafewbigwins

thatmorethanoffsetalargernumberofsmalllosses.

Inreferencetothesurfingterminology,trendfollowingisaboutgettingbackontheboardand

waitingpatientlyuntilthebigwavecomesinandridingitintoshore.Onebigwavecanmake

upforalltheothersmaller,missedwaves.

Howtofindatrend

Traderswhofollowtrendstypicallyusetechnicalindicatorsratherthanrawpricechartsto

identifytrends.

Theydothisbecauseindicatorsprovideanobjectivewayofestablishingwhenatrendis

underwayandtheyareeasytoprogramintotrendfollowingtradingsystems.Evenso,some

tradersdorelyonnakedpricedataknownaspriceactiontofindtrends.Thoughthisisa

muchmoreriskyapproach.

Movingaverages

Oneofthemostpopularindicatorsforidentifyingtrendsisamovingaverage.Thisisbasically

theaverageofthepriceforthepreviousseveraltradingintervals.Whenasmallernumberof

intervalsisused,thisisknownasafastmovingaverage,sinceitreactsquicklytochangesin

price.

Whenalargernumberofintervalsareusedaslowmovingaveragethenthistendsto

changemoreslowly.Thebenefitsofusingamovingaveragearethatittendstoeliminateany

shorttermfluctuationsinthemarket,givingamoreaccurateviewoftheoverallmarket

direction.

Tradersusemovingaveragestodeterminewhetherornotatrendisdevelopingandtypically

usetwomovingaveragestogetherafastoneandaslowone.

Whenthefastmovingaveragecrossesovertheslowone,thisisanindicationthatanupward

trendisunderwayandisusuallyastrongbuysignal.

Ifthefastmovingaveragethenfallsbelowtheslowmovingaverage,adownwardtrendis

underwayandthetrendtraderwillsell.

Breakouts

Anotherpopularwayofspottingatrendistolookforbreakoutsthesearerelativelyeasyto

seeoncharts.

Here,thetraderwilllookforapricetobreakoutofitstradingrangeandmakeanewhigh.For

instance,ifthestockhasbeentradingbetween$2.20and$2.30forthelast50days,andthen

risesto$2.35,thenthisisastrongsignalthatanupwardtrendmaybeforming.Different

tradersusedifferentintervalsthe50dayintervalaboveisjustanexamplesincethereare

differingopinionsonwhichintervalspredictthemarketmostaccurately.

Mosttrendfollowersusetradingprogramstotestwhichtimeintervalsworkbestforfinding

profitablebreakoutsthenworktheseintotheirtradingsystems.

Otherapproaches

Therearehundredsofotherindicatorsthattrendtraderscanuse.Manytradersusetheseto

getanextraedge,buttheriskisthattheymaketradingtoocomplicatedwhichcanleadto

mistakes.

SomeofthemostpopularoftheseotherindicatorsincludeBollingerBandsandmoving

averageconvergence/divergence(MACD).Anotherpopularindicatoristherelativestrength

index(RSI),whichmeasureshowstronglythemarketismovingupordown.Thisisusedboth

todeterminewhenthetrendisstrongandlikelytocontinueaswellaswhenthetrendis

toostrong,inwhichcasethemarketmaybecomeoverboughtoroversold,leadingtoaprice

trendreversal.

Ultimately,itsimportanttofocusontheendgoal,whichistocapitaliseonlongtermtrends.

Simplestrategiesoftenworkjustaswellasmorecomplexonesinthis.

Managingrisk

Asdiscussedpreviously,trendtradersdonotexpecttomakeaprofitoneverytrade.

Generally,trendfollowerswinaround30%40%oftrades.

Becauseofthis,itbecomesveryimportantforthemtolimittheamounttheyloseonthe

tradesthatdontworkout.Thisisthedisciplineofriskmanagement.

Thefirstprincipleofriskmanagementisnottoriskadisproportionatelylargeamountofyour

totalcapital.Mosttraderswilllimittheirrisktolessthan2%onanyonetrademeaning,for

example,thattheywillnotriskmorethan$200iftheirtotalcapitalis$10,000.

Ofcourse,thatdoesntmeanthattheyonlymakea$200investment.Whatitdoesmeanis

thattheylookatthemaximumthattheycanloseonthetrade,andthenusethistoestablish

howmuchtheyinvest.

Forexample,theymightbuyastockat$2.10,andthenplaceastoporderwhichistriggeredif

thestockhits$2.00.Theyareexpectingthestocktorise,butifitdoesfall,thenthemaximum

thattheycanloseis$0.10pershare.Thismeansthattheycanaffordtobuy2000sharesand

onlyrisk$200.Inthiscase,theirtotalinvestmentis$4200whichissignificantlymorethan

the$200theyarerisking.

Stopsornot

Importantly,sometrendfollowersmayusestopsandsomemaynot.

Intheexampleabove,usingastoplosslimitsthedownsideofapotentiallosingtradebutit

alsoensuresthatyouexitatradeataloss.

Itsforthisreasonthatsometrendfollowersfindstoplossescanunderminetheiroverall

performance.Inthisinstance,itsworthdoingsomeinvestigationintowhatkindsofstops

workthebestforthestrategyinquestion.

SometraderspreferdifferenttypesofstopssuchastheChandelierstoporvolatility

measuredstops.Othertradersprefertousestopsthatonlygettriggeredveryoccasionally.

Theyreasonthatastopoftenexitsatradeattheworstpossibletime.Itsthereforefarbetter

touseanexitstrategythatdoesnotinvolveastoploss.

Forexample,ifyoubuyamarketonaEMAcrossover,youshouldsellonanEMAcrossover

too.Byoptimisingriskyoucanestimatethatyouraveragelossrarelyexceeds1%or2%.This

canbepreferabletoriskingaset1%or2%oneverytradesincemarketsareneverso

predictable.

Risk:reward

Traderswillalsolooktoseeagoodrisk/rewardratioontheirtrade.Forexample,iftheyare

risking$0.10pershare,asintheexampleabove,thentheywilltypicallylookforatrade

wherethepotentialprofitisthreetimesormoretheyareexpectingthestocktogoupbyat

least$0.30.Infact,sometraderswilllookforamultipleof5to1.

Toestablishwhatthepotentialprofitis,theywillanalyzesimilarpasthistoricaltrades,andwill

alsolookatothertechnicalindicatorstodeterminewhatthepricemovementislikelytobe.

Trendtradingsystems

Trendtraderstendtotakeamathematicalapproachtotrading,relyingonindicatorstodecide

whichstockstotradeandwhen.Unlikefundamentaltraders,whotendtoapplymore

individualjudgment,trendtraderstendtosticktothenumbers.

Wevealreadydiscussedoneexampleofthisusingcrossovermovingaveragesasasignal.

Infact,oneofthemostcommonoftheseiswhenthe50daymovingaveragerisesabovethe

200daymovingaverage,crossingitfrombeneaththisisknownasagoldencross.

Similarly,whentheoppositecrosshappensthe50dayaveragefallsbelowthe200dayone

thisisknownasadeathcross.Onesystemcouldbetobuywhenagoldencrossoccurs,

andsellwhenadeathcrossshowsup.

Becausethisisaverywelldefinedstrategy,itiseasytogobackandseeifthestrategywould

havegeneratedprofitsusinghistoricaldata.Thetrendtradercanthendiscardanystrategies

thatobviouslydontwork,andthenoptimizetheonesthatdobychangingtheparameters

forexample,usingperiodsotherthan50and200forthetwomovingaverages.

Ofcourse,thisisaverysimpleexampleofatradingsystemandbecauseofitsnotorietyits

unlikelythatitwillproducestaggeringreturnsanymore.Trendfollowingsystemscanbemuch

morecomplicatedofcourse.

Becausetheyareallwelldefined,theyarerelativelyeasytoautomateusingcomputerized

tradingsystems.Thisnotonlyreducestheamountofmanualworkthatthetraderneedsto

do,italsotakesalotoftheemotionoutoftheequationwhichisimportant,sinceemotions

oftenleadtotradingmistakes.

Eveniftheyareabletocompletelyautomatetheirtrading,however,trendtradersshouldnt

maketheirsystemstoocomplex.Firstofall,thismeansthattheycouldfailinunexpected

waysmorecomplexitymakessystemsmoreunpredictable.Atthesametime,thereisthe

riskthattheydevelopasystemthatfitsallthehistoricaldataperfectlyjustbecauseithas

beentunedtodothatbutreallyhasnovaliditywhenitcomestoanticipatingfuturemarket

behavior.

Curvefittingandotherbiases

Indeed,tradingsystemsthatworkwellonpastdatadonotalwaysworkwellonfuturedata.

Curvefittingasystemtopastdataisjustoneofanumberofbiasesthatatraderneedsto

overcomeinordertodevelopasystemthatisrobustandreadytouseonrealmarkets.

Selectionbiasdictatesthatatradingsystemsperformancecouldjustbebychance,while

survivorshipbiascanimpactonasystembynottakingintoaccountsecuritiesthathavesince

fallenoffoftheexchange.

Tradersneedtounderstandtheprinciplesofsoundsystemdesigninordertocreateasystem

thatwillnotfailonlivemarkets.Sincethereisnoquickerwaytothepoorhousethanby

followingabadlydesignedtradingsystem

Doestrendfollowingworkonstocks?

Beforewegomuchfurtheritsworthdemystifyingacoupleofthingsaboutsuccessfultrend

following.

Firstly,thereareveryfewtrendfollowingfundsintheworldthattradestocksaloneandthe

reasonforthisisthatacoreelementofsuccessfultrendfollowingisdiversification.

Putsimply,individualstocksareverycloselycorrelatedtheytendtoallmoveuptogetherand

allmovedowntogetherthereforetrendfollowingonstocksneedstobedoneslightly

differently.

Instead,mosttrendfollowingfundsarerunbyCTAs(commoditytradingadvisors)andthey

typicallytradeadiversifiedbasketofdifferentfutures.Commoditiessuchasgold,wheat,

crudeoil,bondssuchasUSTreasuries,currenciesandstockindices.

Manytrendfollowingfundstradearound60differentfuturesmarketsandtheyusecorrelation

matrixestospreadtheirriskoverdifferenttypesofmarkets.

Butbacktotrendfollowingonstocksanditsclearthatthestrategycanperformwellon

stockssolongasitistailoredsufficiently.

Thereareseveralacademicpapersthatsuggesttrendfollowingisaviableoptionwhen

tradingstocksbuttherearesomekeytakeawaystotakenoteof.

Firstly,shortingstocksisshowntobenotveryeffectiveintrendfollowingmodelssincestocks

haveaninherentupwardbias.Unlikeacurrencypairwhichisunbiasedtoeitherdirection,

moststocksareproductiveassetsthatmovehigherovertimeaccordingtoearningsand

inflation.

Asaresult,diversificationwhentrendfollowingstocksishardtocomebyandthismeansthat

atrendfollowingapproachcannotbeexpectedtoperformatitsmaximumallthetime.

Therewillcomebearmarketyearswherestocksgodownandinthisinstance,atrend

followingstockportfoliowillfinditnearimpossibletomakemoney.

Thesolutiontothismaybetofindafilterormarkettimingmechanismsomewaytoswitch

outofstockswhentheoverallmarketisenteringabearstage.Perhaps,whenthebroader

marketindexistrendingdown,trendfollowingfundscanmoveoutofstocksandintocash,or

bonds.

Overall,theevidencesuggeststhattrendfollowingworksonstocksforthesamereasonit

worksonothermarketsitenablesthecaptureoflongtailreturns,thestocksthatgoupand

upandup.

Famoustrendfollowers

Interestinglyenough,onceyoutakeoutfamousinvestorssuchasWarrenBuffettorGeorge

Soros,someofthemostfamoustradersofalltimecanbedescribedastrendfollowers.

(EvenGeorgeSoros,whotakesaheavyfundamentalapproachtotrading,reliesonriding

trendsandhisowntheoryofreflexivity.Inaway,Sorostechniqueisbasedonfollowing

trendsandstayingwithmarketsthataremovinginonedirection).

OneofthemostwellknowntrendfollowersisJesseLivermore,atraderfromtheGreat

DepressionerawhowasimmortalisedintheclassictradingbookReminiscencesofaStock

Operator.Livermoremadeandlostmanyfortunesduringhiscareerandhiswritingsarestill

thecornerstoneofmoderntrendfollowingstrategies.

Livermorewouldnothavehadamechanicalsystemassuch,butwhathedidhave,wasan

abilitytobuystocksthatweregoingupandsellstocksthatweregoingdown.Healso

preferredtocutlossesshortandlearntfromexperiencethattherewasoftenmoremoneyto

bemadebydoingnothingthanbytryingtocatcheverylittlemoveinthemarket.

AlittlelaterthanLivermore,NicholasDarvaswasanothertrendfollowerwhomadeitbigin

themarkets,turning$25,000into$2,000,000injustacoupleofyearsduringthe1950s.

Darvasapproachwasbasedonboxes.Hewoulddrawboxesaroundtherecentpriceaction

andwhenastockbrokeoutoftheboxhewouldbuyitandridethetrendhigher.Whenthe

stockfellbackintotheboxhewouldsellandhewouldalwayspreferthestrongestmomentum

stocks.

ThelateRichardDonchianwasanothertrendfollowingpioneerwhowasaroundfromthe

1960sandDonchianalsobegantheprocessofcomputerisedtradingwhichinspiredfellow

trendfollowerEdSeykota.

OtherfamoustrendfollowersincludeRichardDennisandtheTurtleTraderswhowere

profiledintheoriginalMarketWizardsbookbyJackSchwager.Dennismademanymillions

tradingasimplebreakoutstrategyinthecommoditiesmarketsandtaughtthestrategytoa

bunchofstudentswhohadnoexperienceinthemarkets,whoultimatelyalsomademillionsof

dollars.

WilliamEckhardtwasDennispartneratthetime,andEckhardtstilloperateshisflagship

trendfollowingfundtoday.Itsbeengoingsince1980sandhasover$300millionassets

undermanagement.

OtherhighprofiletrendfollowingfundsthatareinoperationtodayincludeBillDunnsDunn

Capitalwhichreturnedover50%in2008,MichaelClarkesClarkeCapital(foundedin1993)

andDavidHardingsWintonCapitalwhichholdsover$24billioninassets.

Indeed,2008wasastandoutyearfortrendfollowingfundsasthestrategywasabletomake

moneywhilenearlyeveryotherstrategyfelldeepintothered.

Followingisalargerlistofhighprofiletrendfollowingfundsthatexisttoday:

AbrahamTradingfoundedbySalemAbraham.

AltisPartners.

BeachHorizonfoundedbyDavidBeach.

BlueTrend,fromBlueCrestCapital.

Campbell&Company.

ChesapeakeCapitalfoundedbyJerryParker.

ClarkeCapitalfoundedbyMichaelClarke.

CovenantCapital.

DruryCapitalInc.

DunnCapitalfoundedbyBillDunn.

EckhardtTrading.

EMCCapitalfoundedbyLizCheval.

HawksbillCapital.

MillburnRidgefield.

MulvaneyCapitalManagement.

SunriseCapital.

Transtrend.

WintonCapital.

Whathappenedin2008?

Asmentionedabove,trendfollowerscleanedupin2008asstockmarketsimplodedandhuge

pricemoveswereseenacrossmanydifferentmarkets.

Oneincorrectassumptionisthattrendfollowersmadeallthatmoneyin2008shortingstocks

butthatisntthecaseatall.Trendfollowersrarelyshortindividualequitiesandalotofthe

moneymadebytrendfollowerswasinotherareas.

Inparticular,trendfollowersmadebigmoneyfromUSTreasuriesandbondswhichsoared

duringthefinancialcrisis.Theywerealsoabletocapturebiggainsincrudeoil,onthelong

sideandontheshortsidewhenthecommodityreversed.

Manyalsodidwellinothercommoditymarketsporkbellies,sugarandgold.Andtherewere

bigprofitstobemadetooincurrencypairssuchasGBP/USDandUSD/JPY.

Asmentionedearlier,acrucialpartofsuccessfultrendfollowingisdiversificationandin2008,

wesawmanyuncorrelatedmarketspostbigtrendsindifferentdirections.Nearperfect

conditionsfortrendfollowing.

Istrendfollowingdead?

Since2008,theperformanceoftrendfollowinghasbeenmoresporadiccausingsometo

claimthatthestrategynolongerworks.2011wasaparticularlychoppyyearfortrend

followersandsawmosttrendfollowingfundsfinishtheyearinthered.

Buttheyearseithersideof2011havenotbeenkindeitherandmosttradershavefoundit

hardtomatchtheimpressivereturnswitnessedinstocks.

Belowisachartshowingtheaggregatedperformanceofanumberoftrendfollowingfunds

compiledbyiasg.com.Noticehowtheindexhasbeeninadrawdownsince2011.

Thetableofresultsalsoshowshowtrendfollowinghasbeenlesssuccessfulinrecentyears:

However,thetruthisthattrendfollowinghasbeenclaimednottoworkmanytimesbeforeand

wheneverthatshappeneditsusuallybeenagoodtimetostarttrendfollowingagain.

Itisworthrememberingthattheaveragetrendfollowingfundmademoneynearlyeveryyear

between1994and2009soitsperhapsonlynaturalforthestrategytohaveaslowerperiod.

Especiallyconsideringtheattention,andthereforenewtraders,itsgainedsince2008.

Whatdotrendfollowerssay?

Nevertheless,therearestillsomeoftheopinionthattrendfollowinghasseenitsbestdays.

EvenWintonCapital,oneofthelargesttrendfollowingfunds,releasedapaperarguingthat

althoughtrendfollowingisnotdead,therehasbeenevidenceofadegradationin

performance.

WintonsaidWefindtrendfollowingsystemstobeeffectiveinforecastingfutureprice

movements,butweobserveasignificantandpersistentdeclineintheforecastingabilityof

thosewiththefastestturnover.HistoricalPerformanceOfTrendFollowing,December2013.

Anditsalsoworthnotingtheclosureofonewellknowntrendfollowingfundin2012thatof

JohnWHenry,whoisalsoowneroftheBostonRedSox.

Moreover,sometrendfollowerslaytheblameattheFederalReserve,claimingthatthe

excessofliquidityhascreatedanartificial,lowinterestrateenvironmentthathasseennormal

trendshardtocomeby.

Forme,thatseemslikeapoorargument.Inmyeyes,trendfollowingispreciselythestrategy

thatisintendedtoprofitfromsuchunusualperiodsofmarketactivity.Hugelevelsofmonetary

stimulusshouldleadtobigtrendsandultimatelybubbles.Thesearethelongtaileventsthat

trendfollowingissupposedtothriveon.

Myhunchisthatitsonlyamatteroftimebeforerecordlevelsofstimulustranslateintohuge

financialtrendsandbubbles,andwhenthathappens,trendfollowingwillhaveitstimeinthe

sunonceagain.

UpdateMarch2015:AsofMarch2015,itdoesindeedseemthatthenaysayersweretooquicktocastasidethestrategyoftrendfollowing.Takealookthroughtheperformanceofthe

majortrendfollowingfundsandyouwillseethat2014wasoneofthebestyearseverfor

trendfollowing.MulvaneyCapitalinparticularreturnedover60%.

Conclusion

Pricetrendshavealwaysbeenandalwayswillbeakeyfeatureoffinancialandequity

markets.Insomecases,theyarelinkedtoexternalevents,butinmanycasestheyaredriven

bytechnicalfactorsorbythesentimentofmarketparticipantsindependentoffundamental

drivers.

Traderswhounderstandthisandcanbothidentifyandexploittrendshavethepotentialto

generatelargeprofits.

However,anyonewhoisconsideringgettingintotrendtradinghastounderstandthattheyare

notgoingtowinallofthetime.Theyneedtotakeascientificapproachtotrendtrading,

eliminatinganyemotionalinvolvementwhetherthatisthethrillofvictoryortheagonyof

defeat.

Giventhatthemajorityoftrendtradeswillnotworkout,theymustntcommittoomuchcapital

toanyonedeal,andmustensurethattheirpotentiallossesarewellunderstoodandlimited.

Appendix

1. Testinga50daymovingaveragestrategyonstocks

Oneverybasicbutpopulartrendfollowingstrategyisbasedonthe50daymovingaverage.

Butcanthissimplestrategycanworkintodaysmarkets?

50DayMovingAverageStrategy

Totestthe50daymovingaveragestrategyIloadeduptheAmibrokertradingplatformand

wrotesomebasiccode.Inthisfirsttest,thesystembuysastockwhenthe50daymoving

averagecrossesoverthe200daymovingaverage.Itsellswhenthe50daymovingaverage

crossesbackunder.

(Thisisaportfoliosystemthatholdsamaximumof10stocksatanyonetime.Riskisdivided

into10equalpositionsandcommissionsaresetat$12pertrade.Thiswastestedonstocks

intheS&P1500USstockuniversebetweenAugust2000andAugust2010.Tradesare

enteredonthenextdayopen.)

Test1:

Buy=50dayMA(closeprice)crossesover200dayMA.

Sell=50dayMAcrossesunder200dayMA.

Results:CAR:16.94%MaxDrawdown:54%

Source:Amibroker

Asyoucansee,overstocksintheS&P1500between2000and2010,thissimple50day

movingaveragestrategyactuallydidverywell.

BearinmindthatthebuyandholdreturnontheS&P599wasjustover2%(nominalreturn)

overtheperiodwitha57%maximumdrawdown.

2.29rulesfortrendfollowingonstocks

1.Priceiseverything.

2.Ignorethenews.

3.Buyastockwhenitbreaksoutofarange.

4.Sellastockwhenthetrendchanges.

5.Buyastockwhenitmakesanewhigh.

6.Shortastockwhenitmakesanewlow.

7.Itshardertoshortstocksthanitistobuystocks.

8.Somestockstrendmorethanothers.

9.Diversifywhenyoucan.

10.Ignorethewhipsaws.

11.Dontchasethemarket.

12.Letyourwinnersrun.

13.Cutyourlossesshort.

14.Astockcanalwaysgohigherandalwaysgolower.

15.Dontgetoutbeforethetrendchangesdirectionlooktocatchthemiddle.

16.Trendfollowershavemorelosersthanwinners.

17.40%isagoodpercentageofwinnersfortrendfollowingstocks.

18.Putyourstopsfarenoughawaytoallowthetrendtodevelop.

19.Dontfallinlovewithastock.

20.Dontpickbottoms.

21.Dontpicktops.

22.Donttryandpredictthemarketgowiththeflow.

23.Followyoursignals.

24.Tradesmallenoughyouwontgobrokeandlargeenoughtomakeitworthwhile.

25.Compoundyourreturns.

26.Trendfollowingstocksworksbestwithasystem.

27.Backtestyoursystem.

28.Dontforgetdelistedstocks.

29.Sticktothesystem.

3.TrendFollowingForStocks:CompleteTradingSystem

Thereissignificantevidencethattrendfollowingstrategiescanworkjustaswellonstocksas

onfutures.Bigtrendsexistinthestockmarket,justlikeanyotherassetclass.Andexploiting

thosetrendscanbehugelyprofitable.

ItsforthisreasonthatIdecidedtocomeupwithacompletetrendfollowingtradingsystemfor

stocksandmakeitavailabletothosethatareinterested.

Thisstrategyisnotjustabouttherightbuyandsellrules,itsaboutthewholeprocessof

portfoliomanagement,tradingsignals,andfollowingtherightmethodsforgaininganedge.

AlotoftimehasbeenputintotestingdifferentrulesandIamnowverypleasedwiththe

systemsoutofsampleresults,(+45%in2013forexample).Thefullsystemequitycurvecan

beseenbelow:

Astheequitycurveaboveshows,thisisahighperformingstrategywithareasonable

drawdown.Thestrategyhasbeenabletowithstand30yearsofmarketconditions,through

bothbullandbearmarkets.Thissystemwastestedonreliable,survivorshipbiasfreedata

andhasdeliveredmillionsofdollarsintradingprofits.

FormoredetailsaboutTrendFollowingForStocks:AcompleteTradingSystem,pleaseseehttp://jbmarwood.com

http://jbmarwood.com/