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TrendFollowing101

Aconciseguidetotradinglongandshort

CopyrightJBMarwood2014/2015

JBMarwoodhasassertedhisrighttobeidentifiedastheauthorofthisworkinaccordance
withtheCopyright,DesignsandPatentsAct1988.

Allrightsreserved.Nopartofthispublicationmaybereproduced,storedinaretrievalsystem,
ortransmittedinanyformorbyanymeans,electronic,mechanical,photocopying,recording
orotherwise,withoutthepriorpermissionofthecopyrightowner.

DISCLAIMER

Thisbookisaneducationaldocumentandissoldwiththeunderstandingthatneitherthe
authororpublisherwillacceptanyresponsibilityforlossesorriskasadirectorindirectresult
ofusingideas,applicationsortradingsystemsdescribedinthisbook.Tradingsystemsare
presentedinafairandaccuratewaybutmaybenefitfromextratestingandfurther
customisation.Tradinginfinancialinstruments(suchasequities,fixedincome,foreign
exchange,futures,options,CFDsandallothertypesofexchangetradedoroverthecounter
financialinstruments)carriesahighdegreeofriskandisonlysuitableforinvestorswhoare
abletosustainsubstantiallosses.Inthecaseofmargintrading(suchasfutures,options,
CFDsorleveragedequitytradingforinstance),theriskoflosscouldbegreaterthanthe
amounttheinvestorhasinitiallydepositedintohis/heraccount.

Formoretradingideas,systemsandstrategiesvisit:

http://jbmarwood.com

CONTENTS

Introduction
Priceisking
Notjusttechnicalanalysis
Searchingforthelongtail
Trendfollowingbasics
Howtofindatrend
Movingaverages
Breakouts
Otherapproaches
Managingrisk
Stopsornot
Risk:Reward
Trendtradingsystems
Curvefittingandotherbiases
Doestrendfollowingworkonstocks?
Famoustrendfollowers
Whathappenedin2008?
Istrendfollowingdead?
Whatdotrendfollowerssay?
Conclusion
Appendix1.MovingAverageStrategy
Appendix2.29rulesfortrendfollowingonstocks
Appendix3.TrendFollowingForStocks:CompleteTradingSystem

Wikipedia:
Trendfollowingisaninvestmentstrategybasedonthetechnicalanalysisof
marketprices,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
side
and
ontheshortsidewhenthecommodityreversed.

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,itdoesindeedseemthatthenaysayersweretoo
quicktocastasidethestrategyoftrendfollowing.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,
pleasesee
http://jbmarwood.com

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