TrendFollowing101

Aconciseguidetotradinglongandshort

FirstpublishedbyTheNewMinimalistin2014
CoverandbookdesignbyTheNewMinimalist2014
www.thenewminimalist.com

CopyrightJoeBMarwood2014

JBMarwoodhasassertedhisrighttobeidentifiedastheauthorofthisworkinaccordancewiththe
Copyright,DesignsandPatentsAct1988.

Allrightsreserved.Nopartofthispublicationmaybereproduced,storedinaretrievalsystem,or
transmittedinanyformorbyanymeans,electronic,mechanical,photocopying,recordingorotherwise,
withoutthepriorpermissionofthecopyrightowner.

DISCLAIMER

Thisbookisaneducationaldocumentandissoldwiththeunderstandingthatneithertheauthororpublisher
willacceptanyresponsibilityforlossesorriskasadirectorindirectresultofusingideas,applicationsor
tradingsystemsdescribedinthisbook.Tradingsystemsarepresentedinafairandaccuratewaybutmay
benefitfromextratestingandfurthercustomisation.Tradinginfinancialinstruments(suchasequities,fixed
income,foreignexchange,futures,options,CFDsandallothertypesofexchangetradedoroverthe
counterfinancialinstruments)carriesahighdegreeofriskandisonlysuitableforinvestorswhoareableto
sustainsubstantiallosses.Inthecaseofmargintrading(suchasfutures,options,CFDsorleveraged
equitytradingforinstance),theriskoflosscouldbegreaterthantheamounttheinvestorhasinitially
depositedintohis/heraccount.

Formoretradingideas,systemsandstrategiesvisit:

http://jbmarwood.com

CONTENTS

Introduction
Priceisking
Notjusttechnicalanalysis
Searchingforthelongtail
Trendfollowingbasics
Howtofindatrend
Movingaverages
Breakouts
Otherapproaches
Managingrisk
Stopsornot
Risk:Reward
Trendtradingsystems
Curvefittingandotherbiases
Doestrendfollowingworkonstocks?
Famoustrendfollowers
2008
Istrendfollowingdead?
Whatdotrendfollowerssay?
Conclusion
AppendixMovingAverageStrategy
Appendix29rulesfortrendfollowingonstocks
Resources

Wikipedia:Trendfollowingisaninvestmentstrategybasedonthetechnicalanalysisofmarket
prices,ratherthanonthefundamentalstrengthsofthecompaniesorsecurities.

Introduction

Ifyoulookataselectionofcharts,itbecomesrapidlyobviousthatpricestendtomovein
particulardirectionseitherupwardordownwardforextendedperiodsoftime.Inmanycases,
theremaybenoobviousfundamentalreasonwhythisisoccurringbutitis.Thesearetrends
andsuccessfultradersgeneratesignificantprofitsbyidentifyingandfollowingthem.

AccordingtotheWikipediadefinitionabove,trendfollowingisbasedontechnicalanalysis.In
reality,Iwouldsaythatthisisonlypartlytrue.

Technicalanalysiscanincludeanynumberofdifferenttechnicalindicatorsandstrategies,many
ofwhichhaveverylittlevalue.Trendfollowingontheotherhandismorephilosophicalthana
simpletechnicalanalysisapproach.

Itisthebeliefthattrendsexistacrossnumerousmarketsandindustriesandevenmore,that
thereisareasonforthemexisting.Itisthebeliefthatthepriceofasecurityisthemostimportant
thingtounderstandandeverythingyouneedtoknowaboutamarketcanbeascertainedfromits
priceaction.

Itisalsothebeliefthattrendscanlastformuchlongerperiodsthanexpectedandtrendfollowing
isanapproachdesignedtocapturethelongtailofmarketreturns.

Recentmediacoverageoftrendfollowinginsiststhattheapproachisoutofdateandsome
commentatorshaveevenproclaimedthattrendfollowingisdead.Iwillcometothislateron.For
now,letstakealookatwhattrendfollowingisandwhatitisnt.


Priceisking

Investorsusetechnicalanalysistoidentifytrends,todeterminewhentoenterthemarket,andto
formulatetheirexitstrategy.However,allthisanalysisisreallytargetedattryingtoanticipate
pricemovementsandpriceistheoverridingprinciplebehindtrendfollowing.

Thekeytenetoftrendanalysisandthemantraoftrendfollowersisthatpricecantell
investorseverythingthatisimportantaboutasecurity.Ittellsthemhowthestockhasperformed
inthepast,whereitisnow,andwhatthefutureislikelytoholdforit.

Becauseofthis,trendfollowersfocusonpricemovements,ratherthantryingtouse
fundamentalfactorssuchaseconomicdata,geopoliticaleventsandothermacroeconomic
factorstopredictperformance.Inessence,theybelievethatthemarketisalwaysrightandthat
profitscomefromfollowingwhatthemarketisdoingatthatprecisemomentratherthantryingto
predictwhatwillhappennext.

Ifyouconsideralltheinputsandinformationthatexistinthefinancialmarketsyouwillrealisethat
attemptingtounderstandwhatcausesamarkettomoveinacertainwayisnearimpossible.

Forexample,canyoureasonablyexpecttoknowalltheinformationaboutaparticular
companysfinances?Canyouevenbegintounderstandtherelationshipsthatgointothesupply
anddemandconstraintsofaparticularcommodity?

Trendfollowersarguethatattemptingtoanalysefundamentalsisfutile.Everythingthatyouneed
toknowaboutamarketitreflectedinitsprice.Thepriceisallyouneedtoknowandamarket
thatisgoingupshouldbebought,whileamarketthatisgoingdownshouldbesold.


Notjusttechnicalanalysis

Sometrendfollowersclaimthatwhattheyaredoingisnotjusttechnicalanalysis.Theypointto
theexistenceoftrendsacrossmanysphereseconomic,political,fashion,technologicalto
arguethattrendsexistacrossallareas.

Thisisareasonableclaim,butitisworthwhiletorememberthattrendsarealsotiedtounique
marketphenomena.

Forexample,investorenthusiasmcandrivetrendstoextremeswithoutanyfundamental
underpinningintheendthiscanmakethemsusceptibletopainfulreversalsbutthetrend
followerwillusuallyhavemademanyhundredsofpercentalongtheway.

Thedot.comboomisagoodexampleofthis,buttherearemanymorerepresentativecases
throughouthistory,includingtheDutchTulipManiainthe17thcentury,andtheSouthSea
Bubbleinthe1800s.

Therearealsoshorttermfactorsatplay,suchaswhenthemarketbecomesoverboughtor
oversoldwhichcanleadtoatrendstallingorevenreversing.Thissortofshorttermtechnical
phenomenonreallyhasnoexactcorollaryinotherareasoutsideofthemarkets.

Searchingforthelongtail

Backin1909,HenryFordmadethestatementthatAnycustomercanhaveacarpaintedany
colourthathewantssolongasitisblack.ThiswasinreferencetotheModelT,thecarthat
madeFordapowerhouseintheautomotiveindustry.Thisisaperfectexampleofmass
marketing,whichtargetsthevastmajorityofconsumerswithaverynarrowproductoffering.

Infact,thisiscapturedinthe80/20ruleorParetoprinciplewhichassertsthat80%ofcases
canbeaddressedbycovering20%ofthetotalsetofrequirements.Thisisacharacteristicof
manymathematicaldistributions,whichseethevastmajorityofitemsclusteredcloselytogether
withonlyafewoutliers.

However,thisprincipledoesntalwaysholdparticularlyincaseswherethereisalongtail
distribution.Thisiswhenadisproportionatelyhighnumberofcaseslieoutsideofthecentral
peakofthedistribution.

Thisdistributioncanbeseeninmanyareassuchasrecenttrendstowardsmass
personalization,aswellasthesuccessofcompaniessuchasAmazon,whichtargetthelong
tailwithahugearrayofproducts,ratherthansellingafewproductstoamassmarket.

Infact,inalongtaildistribution,lessthan50%ofcasesfallintothatcore20%ofrequirements,
makingchasingthelongtailhighlyprofitableformanybusinesses.

Thesamelongtailprincipleappliesforinvestorswhofollowtrends.Longtailsarecharacteristic
offinancialmarketsforexample,ifyoulookatabroadselectionofstockreturns,youllfindthat
someofthemmoverelativelylittleoverayearmaybe5%or10%buttherearealsoa
disproportionatelyhighnumberofstocksthatmakemuchlargerpricemoves50%,100%,
200%orevenmoreinsomecases.Thesearethelongtailstocksthattrendfollowersare
hunting,sincetheyofferthebiggestopportunityforprofits.

Trendfollowingbasics

Becausetrendfollowersaretryingtocatchthelongtail,theytypicallyadoptarelatively
straightforwardstrategy.Theybuywhenthemarketisrising,andsellwhenitsonitswaydown.
Whattheyhopeisthattheyaregettinginonthestartofatrend,whichtheythenridetoits
profitableconclusion.Theydontactuallycarewhetherthemarketisrisingorfallingtheyare
unbiasedandcanmakeprofitsinbothcases.

However,becauseofthelongtailnatureofthemarket,someofthesetrendswillbeshortlived
orevennonexistent.Itsabitlikewavesatseatherearetinyripples,somebiggerwavesand
theoccasionalmonster.Thebigwavesandthemonstersarewheretrendfollowersmaketheir
profitsbut,theyalsofindthemselvestryingtoridetheripples.Worsestill,theyfindthatthe
waveismovinginthewrongdirectiontheyexpecttobeliftedup,buttheyfindthemselves
fallingofftheotherside.

Becauseofthis,trendfollowersnotonlyneedtojumponwavesthatlookhopefulinother
words,arisingorfallingstocktheyalsoneedtobepreparedforwhenthingsgowrong.While
theyneedtoridethewinnerstotheirconclusion,theyalsoneedtogetoutquicklyandcuttheir
lossesonlosingtrades.Iftheydidntdothis,thelosseswouldoverwhelmthewins,leadingtoan
inevitableandcostlyresult.Inotherwords,thegoalistohaveafewbigwinsthatmorethan
offsetalargernumberofsmalllosses.

Inreferencetothesurfingterminology,trendfollowingisaboutgettingbackontheboardand
waitingpatientlyuntilthebigwavecomesinandridingitintoshore.Onebigwavecanmakeup
foralltheothersmaller,missedwaves.

Howtofindatrend

Traderswhofollowtrendstypicallyusetechnicalindicatorsratherthanrawpricechartsto
identifytrends.

Theydothisbecauseindicatorsprovideanobjectivewayofestablishingwhenatrendis
underwayandtheyareeasytoprogramintotrendfollowingtradingsystems.Evenso,some
tradersdorelyonnakedpricedataknownaspriceactiontofindtrends.Thoughthisisa
muchmoreriskyapproach.


Movingaverages

Oneofthemostpopularindicatorsforidentifyingtrendsisamovingaverage.Thisisbasically
theaverageofthepriceforthepreviousseveraltradingintervals.Whenasmallernumberof
intervalsisused,thisisknownasafastmovingaverage,sinceitreactsquicklytochangesin
price.

Whenalargernumberofintervalsareusedaslowmovingaveragethenthistendsto
changemoreslowly.Thebenefitsofusingamovingaveragearethatittendstoeliminateany
shorttermfluctuationsinthemarket,givingamoreaccurateviewoftheoverallmarketdirection.

Tradersusemovingaveragestodeterminewhetherornotatrendisdevelopingandtypicallyuse
twomovingaveragestogetherafastoneandaslowone.

Whenthefastmovingaveragecrossesovertheslowone,thisisanindicationthatanupward
trendisunderwayandisusuallyastrongbuysignal.

Ifthefastmovingaveragethenfallsbelowtheslowmovingaverage,adownwardtrendis
underwayandthetrendtraderwillsell.

Breakouts

Anotherpopularwayofspottingatrendistolookforbreakoutsthesearerelativelyeasytosee
oncharts.

Here,thetraderwilllookforapricetobreakoutofitstradingrangeandmakeanewhigh.For
instance,ifthestockhasbeentradingbetween$2.20and$2.30forthelast50days,andthen
risesto$2.35,thenthisisastrongsignalthatanupwardtrendmaybeforming.Differenttraders

usedifferentintervalsthe50dayintervalaboveisjustanexamplesincetherearediffering
opinionsonwhichintervalspredictthemarketmostaccurately.

Mosttrendfollowersusetradingprogramstotestwhichtimeintervalsworkbestforfinding
profitablebreakoutsthenworktheseintotheirtradingsystems.

Otherapproaches

Therearehundredsofotherindicatorsthattrendtraderscanuse.Manytradersusethesetoget
anextraedge,buttheriskisthattheymaketradingtoocomplicatedwhichcanleadto
mistakes.

SomeofthemostpopularoftheseotherindicatorsincludeBollingerBandsandmovingaverage
convergence/divergence(MACD).Anotherpopularindicatoristherelativestrengthindex(RSI),
whichmeasureshowstronglythemarketismovingupordown.Thisisusedbothtodetermine
whenthetrendisstrongandlikelytocontinueaswellaswhenthetrendistoostrong,in
whichcasethemarketmaybecomeoverboughtoroversold,leadingtoapricetrendreversal.

Ultimately,itsimportanttofocusontheendgoal,whichistocapitaliseonlongtermtrends.
Simplestrategiesoftenworkjustaswellasmorecomplexonesinthis.

Managingrisk

Asdiscussedpreviously,trendtradersdonotexpecttomakeaprofitoneverytrade.Generally,
trendfollowerswinaround30%40%oftrades.

Becauseofthis,itbecomesveryimportantforthemtolimittheamounttheyloseonthetrades
thatdontworkout.Thisisthedisciplineofriskmanagement.

Thefirstprincipleofriskmanagementisnottoriskadisproportionatelylargeamountofyourtotal
capital.Mosttraderswilllimittheirrisktolessthan2%onanyonetrademeaning,forexample,
thattheywillnotriskmorethan$200iftheirtotalcapitalis$10,000.

Ofcourse,thatdoesntmeanthattheyonlymakea$200investment.Whatitdoesmeanisthat
theylookatthemaximumthattheycanloseonthetrade,andthenusethistoestablishhow
muchtheyinvest.

Forexample,theymightbuyastockat$2.10,andthenplaceastoporderwhichistriggeredif
thestockhits$2.00.Theyareexpectingthestocktorise,butifitdoesfall,thenthemaximum
thattheycanloseis$0.10pershare.Thismeansthattheycanaffordtobuy2000sharesand
onlyrisk$200.Inthiscase,theirtotalinvestmentis$4200whichissignificantlymorethanthe
$200theyarerisking.

Stopsornot

Importantly,sometrendfollowersmayusestopsandsomemaynot.

Intheexampleabove,usingastoplosslimitsthedownsideofapotentiallosingtradebutitalso
ensuresthatyouexitatradeataloss.

Itsforthisreasonthatsometrendfollowersfindstoplossescanunderminetheiroverall
performance.Inthisinstance,itsworthdoingsomeinvestigationintowhatkindsofstopswork
thebestforthestrategyinquestion.

SometraderspreferdifferenttypesofstopssuchastheChandelierstoporvolatilitymeasured
stops.Othertradersprefertousestopsthatonlygettriggeredveryoccasionally.Theyreason
thatastopoftenexitsatradeattheworstpossibletime.Itsthereforefarbettertouseanexit
strategythatdoesnotinvolveastoploss.

Forexample,ifyoubuyamarketonaEMAcrossover,youshouldsellonanEMAcrossovertoo.
Byoptimisingriskyoucanestimatethatyouraveragelossrarelyexceeds1%or2%.Thiscan
bepreferabletoriskingaset1%or2%oneverytradesincemarketsareneversopredictable.

Risk:Reward

Traderswillalsolooktoseeagoodrisk/rewardratioontheirtrade.Forexample,iftheyare
risking$0.10pershare,asintheexampleabove,thentheywilltypicallylookforatradewhere
thepotentialprofitisthreetimesormoretheyareexpectingthestocktogoupbyatleast
$0.30.Infact,sometraderswilllookforamultipleof5to1.Toestablishwhatthepotentialprofit
is,theywillanalyzesimilarpasthistoricaltrades,andwillalsolookatothertechnicalindicators
todeterminewhatthepricemovementislikelytobe.

Trendtradingsystems

Trendtraderstendtotakeamathematicalapproachtotrading,relyingonindicatorstodecide
whichstockstotradeandwhen.Unlikefundamentaltraders,whotendtoapplymoreindividual
judgment,trendtraderstendtosticktothenumbers.

Wevealreadydiscussedoneexampleofthisusingcrossovermovingaveragesasasignal.In
fact,oneofthemostcommonoftheseiswhenthe50daymovingaveragerisesabovethe
200daymovingaverage,crossingitfrombeneaththisisknownasagoldencross.

Similarly,whentheoppositecrosshappensthe50dayaveragefallsbelowthe200dayone
thisisknownasadeathcross.Onesystemcouldbetobuywhenagoldencrossoccurs,and
sellwhenadeathcrossshowsup.

Becausethisisaverywelldefinedstrategy,itiseasytogobackandseeifthestrategywould
havegeneratedprofitsusinghistoricaldata.Thetrendtradercanthendiscardanystrategiesthat
obviouslydontwork,andthenoptimizetheonesthatdobychangingtheparametersfor
example,usingperiodsotherthan50and200forthetwomovingaverages.


Ofcourse,thisisaverysimpleexampleofatradingsystemandbecauseofitsnotorietyits
unlikelythatitwillproducestaggeringreturnsanymore.Trendfollowingsystemscanbemuch
morecomplicatedofcourse.

Becausetheyareallwelldefined,theyarerelativelyeasytoautomateusingcomputerized
tradingsystems.Thisnotonlyreducestheamountofmanualworkthatthetraderneedstodo,it
alsotakesalotoftheemotionoutoftheequationwhichisimportant,sinceemotionsoftenlead
totradingmistakes.

Eveniftheyareabletocompletelyautomatetheirtrading,however,trendtradersshouldntmake
theirsystemstoocomplex.Firstofall,thismeansthattheycouldfailinunexpectedwaysmore
complexitymakessystemsmoreunpredictable.Atthesametime,thereistheriskthatthey
developasystemthatfitsallthehistoricaldataperfectlyjustbecauseithasbeentunedtodo
thatbutreallyhasnovaliditywhenitcomestoanticipatingfuturemarketbehavior.

Curvefittingandotherbiases

Indeed,tradingsystemsthatworkwellonpastdatadonotalwaysworkwellonfuturedata.
Curvefittingasystemtopastdataisjustoneofanumberofbiasesthatatraderneedsto
overcomeinordertodevelopasystemthatisrobustandreadytouseonrealmarkets.

Selectionbiasdictatesthatatradingsystemsperformancecouldjustbebychance,while
survivorshipbiascanimpactonasystembynottakingintoaccountsecuritiesthathavesince
fallenoffoftheexchange.

Tradersneedtounderstandtheprinciplesofsoundsystemdesigninordertocreateasystem
thatwillnotfailonlivemarkets.Sincethereisnoquickerwaytothepoorhousethanbyfollowing
abadlydesignedtradingsystem

Doestrendfollowingworkonstocks?

Beforewegomuchfurtheritsworthdemystifyingacoupleofthingsaboutsuccessfultrend
following.

Firstly,thereareveryfewtrendfollowingfundsintheworldthattradestocksaloneandthe
reasonforthisisthatacoreelementofsuccessfultrendfollowingisdiversification.

Putsimply,individualstocksareverycloselycorrelatedtheytendtoallmoveuptogetherandall
movedowntogetherthereforetrendfollowingonstocksneedstobedoneslightlydifferently.

Instead,mosttrendfollowingfundsarerunbyCTAs(commoditytradingadvisors)andthey
typicallytradeadiversifiedbasketofdifferentfutures.Commoditiessuchasgold,wheat,crude
oil,bondssuchasUSTreasuries,currenciesandstockindices.

Manytrendfollowingfundstradearound60differentfuturesmarketsandtheyusecorrelation
matrixestospreadtheirriskoverdifferenttypesofmarkets.

Butbacktotrendfollowingonstocksanditsclearthatthestrategycanperformwellonstocks
solongasitistailoredsufficiently.

Thereareseveralacademicpapersthatsuggesttrendfollowingisaviableoptionwhentrading
stocksbuttherearesomekeytakeawaystotakenoteof.

Firstly,shortingstocksisshowntobenotveryeffectiveintrendfollowingmodelssincestocks
haveaninherentupwardbias.Unlikeacurrencypairwhichisunbiasedtoeitherdirection,most
stocksareproductiveassetsthatmovehigherovertimeaccordingtoearningsandinflation.

Asaresult,diversificationwhentrendfollowingstocksishardtocomebyandthismeansthata
trendfollowingapproachcannotbeexpectedtoperformatitsmaximumallthetime.

Therewillcomebearmarketyearswherestocksgodownandinthisinstance,atrendfollowing
stockportfoliowillfinditnearimpossibletomakemoney.

Thesolutiontothismaybetofindafilterormarkettimingmechanismsomewaytoswitchout
ofstockswhentheoverallmarketisenteringabearstage.Perhaps,whenthebroadermarket
indexistrendingdown,trendfollowingfundscanmoveoutofstocksandintocash,orbonds.

Overall,theevidencesuggeststhattrendfollowingworksonstocksforthesamereasonitworks
onothermarketsitenablesthecaptureoflongtailreturns,thestocksthatgoupandupandup.

Famoustrendfollowers

Interestinglyenough,onceyoutakeoutfamousinvestorssuchasWarrenBuffettorGeorge
Soros,someofthemostfamoustradersofalltimecanbedescribedastrendfollowers.

(EvenGeorgeSoros,whotakesaheavyfundamentalapproachtotrading,reliesonriding
trendsandhisowntheoryofreflexivity,inaway,isbasedontrendsandstayingwithmarkets
thataremovinginonedirection).

OneofthemostwellknowntrendfollowersisJesseLivermore,atraderfromtheGreat
DepressionerawhowasimmortalisedintheclassictradingbookReminiscencesofaStock
Operator.Livermoremadeandlostmanyfortunesduringhiscareerandhiswritingsarestillthe
cornerstoneofmoderntrendfollowingstrategies.

Livermorewouldnothavehadamechanicalsystemassuch,butwhathedidhave,wasan
abilitytobuystocksthatweregoingupandsellstocksthatweregoingdown.Healsopreferred
tocutlossesshortandlearntfromexperiencethattherewasoftenmoremoneytobemadeby
doingnothingthanbytryingtocatcheverylittlemoveinthemarket.

AlittlelaterthanLivermore,NicholasDarvaswasanothertrendfollowerwhomadeitbiginthe
markets,turning$25,000into$2,000,000injustacoupleofyearsduringthe1950s.Darvas
approachwasbasedonboxes.Hewoulddrawboxesaroundtherecentpriceactionandwhena

stockbrokeoutoftheboxhewouldbuyitandridethetrendhigher.Whenthestockfellbackinto
theboxhewouldsellandhewouldalwayspreferthestrongestmomentumstocks.

ThelateRichardDonchianwasanothertrendfollowingpioneerwhowasaroundfromthe1960s
andDonchianalsobegantheprocessofcomputerisedtradingwhichinspiredfellowtrend
followerEdSeykota.

OtherfamoustrendfollowersincludeRichardDennisandtheTurtleTraderswhowereprofiled
intheoriginalMarketWizardsbookbyJackSchwager.Dennismademanymillionstradinga
simplebreakoutstrategyinthecommoditiesmarketsandtaughtthestrategytoabunchof
studentswhohadnoexperienceinthemarkets,whoultimatelyalsomademillionsofdollars.

WilliamEckhardtwasDennispartneratthetime,andEckhardtstilloperateshisflagshiptrend
followingfundtoday.Itsbeengoingsince1980sandhasover$300millionassetsunder
management.

OtherhighprofiletrendfollowingfundsthatareinoperationtodayincludeBillDunnsDunn
Capitalwhichreturnedover50%in2008,MichaelClarkesClarkeCapital(foundedin1993)and
DavidHardingsWintonCapitalwhichholdsover$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.

2008

Asmentionedabove,trendfollowerscleanedupin2008asstockmarketsimplodedandhuge
pricemoveswereseenacrossmanydifferentmarkets.

Oneincorrectassumptionisthattrendfollowersmadeallthatmoneyin2008shortingstocksbut
thatisntthecaseatall.Trendfollowersrarelyshortindividualequitiesandalotofthemoney
madebytrendfollowerswasinotherareas.

Inparticular,trendfollowersmadebigmoneyfromUSTreasuriesandbondswhichsoared
duringthefinancialcrisis.Theywerealsoabletocapturebiggainsincrudeoil,onthelongside
andontheshortsidewhenthecommodityreversed.

Manyalsodidwellinothercommoditymarketsporkbellies,sugarandgold.Andtherewerebig
profitstobemadetooincurrencypairssuchasGBP/USDandUSD/JPY.

Asmentionedearlier,acrucialpartofsuccessfultrendfollowingisdiversificationandin2008,
wesawmanyuncorrelatedmarketspostbigtrendsindifferentdirections.Nearperfect
conditionsfortrendfollowing.

Istrendfollowingdead?

Since2008,theperformanceoftrendfollowinghasbeenmoresporadiccausingsometoclaim
thatthestrategynolongerworks.2011wasaparticularlychoppyyearfortrendfollowersand
sawmosttrendfollowingfundsfinishtheyearinthered.
Buttheyearseithersideof2011havenotbeenkindeitherandmosttradershavefoundithardto
matchtheimpressivereturnswitnessedinstocks.

Belowisachartshowingtheaggregatedperformanceofanumberoftrendfollowingfunds
compiledbyiasg.com.Noticehowtheindexhasbeeninadrawdownsince2011.

Thetableofresultsalsoshowshowtrendfollowinghasbeenlesssuccessfulinrecentyears:

However,thetruthisthattrendfollowinghasbeenclaimednottoworkmanytimesbeforeand
wheneverthatshappeneditsusuallybeenagoodtimetostarttrendfollowingagain.

Itisworthrememberingthattheaveragetrendfollowingfundmademoneynearlyeveryyear
between1994and2009soitsperhapsonlynaturalforthestrategytohaveaslowerperiod.
Especiallyconsideringtheattention,andthereforenewtraders,itsgainedsince2008.

Whatdotrendfollowerssay?

Nevertheless,therearestillsomeoftheopinionthattrendfollowinghasseenitsbestdays.
EvenWintonCapital,oneofthelargesttrendfollowingfunds,releasedapaperarguingthat
althoughtrendfollowingisnotdead,therehasbeenevidenceofadegradationinperformance.

WintonsaidWefindtrendfollowingsystemstobeeffectiveinforecastingfutureprice
movements,butweobserveasignificantandpersistentdeclineintheforecastingabilityofthose
withthefastestturnover.HistoricalPerformanceOfTrendFollowing,December2013.

Anditsalsoworthnotingtheclosureofonewellknowntrendfollowingfundin2012thatof
JohnWHenry,whoisalsoowneroftheBostonRedSox.

Moreover,sometrendfollowerslaytheblameattheFederalReserve,claimingthattheexcess
ofliquidityhascreatedanartificial,lowinterestrateenvironmentthathasseennormaltrends
hardtocomeby.

Forme,thatseemslikeapoorargument.Inmyeyes,trendfollowingispreciselythestrategy
thatisintendedtoprofitfromsuchunusualperiodsofmarketactivity.Hugelevelsofmonetary
stimulusshouldleadtobigtrendsandultimatelybubbles.Thesearethelongtaileventsthat
trendfollowingissupposedtothriveon.

Myhunchisthatitsonlyamatteroftimebeforerecordlevelsofstimulustranslateintohuge
financialtrendsandbubbles,andwhenthathappens,trendfollowingwillhaveitstimeinthesun
onceagain.

Conclusion

Pricetrendshavealwaysbeenandalwayswillbeakeyfeatureoffinancialandequitymarkets.
Insomecases,theyarelinkedtoexternalevents,butinmanycasestheyaredrivenbytechnical
factorsorbythesentimentofmarketparticipantsindependentoffundamentaldrivers.

Traderswhounderstandthisandcanbothidentifyandexploittrendshavethepotentialto
generatelargeprofits.

However,anyonewhoisconsideringgettingintotrendtradinghastounderstandthattheyare
notgoingtowinallofthetime.Theyneedtotakeascientificapproachtotrendtrading,
eliminatinganyemotionalinvolvementwhetherthatisthethrillofvictoryortheagonyofdefeat.

Giventhatthemajorityoftrendtradeswillnotworkout,theymustntcommittoomuchcapitalto
anyonedeal,andmustensurethattheirpotentiallossesarewellunderstoodandlimited.

Appendix

Testingatrendfollowingmovingaveragestrategyonstocks
Oneverybasicbutpopulartrendfollowingstrategyisbasedonthe50daymovingaverage.But
canthissimplestrategycanworkintodaysmarkets?
50DayMovingAverageStrategy
Totestthe50daymovingaveragestrategyIloadeduptheAmibrokertradingplatformandwrote
somebasiccode.Inthisfirsttest,thesystembuysastockwhenthe50daymovingaverage
crossesoverthe200daymovingaverage.Itsellswhenthe50daymovingaveragecrosses
backunder.
(Thisisaportfoliosystemthatholdsamaximumof10stocksatanyonetime.Riskisdivided
into10equalpositionsandcommissionsaresetat$12pertrade.Thiswastestedonstocksin
theS&P1500USstockuniversebetweenAugust2000andAugust2010.Tradesareenteredon
thenextdayopen.)
Test1:
Buy=50dayMA(closeprice)crossesover200dayMA.
Sell=50dayMAcrossesunder200dayMA.
Results:CAR:16.94%MaxDrawdown:54%


Source:Amibroker

Asyoucansee,overstocksintheS&P1500between2000and2010,thissimple50day
movingaveragestrategyactuallydidverywell.

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.

Resources:
Forafulllistofuptodatetradingresourcesmakesuretocheckout
http://jbmarwood.com/tradingresources/