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6,362 posts
msg #48041
Ignore TheRumpledOne
11/18/2006 5:48:29 PM

5 questions every trader is asking
By Michael Covel
March 10, 2006 4:00 PM ET

Q1: Trend followers must be doing well in this market; how long will it last?

How long will what last? Trend following as a viable trading style? There is no reason trend following should stop. If markets were to go sideways forever, there would be no trends and then trend following would cease to work.

Trend Following goes against all the customs, rituals, trappings, and myths we have grown accustomed to associating with Wall Street trading success. Trend following traders respond to what is happening in the market rather than anticipating what will happen. And they base their trading decisions on one piece of core information: The market price. That makes them different from the vast majority of traders and investors who rely on fundamental data to make their trading decisions. They think the only way to beat the market is to gather all of the information you can find. They want news, they want CNBC, they want The Wall Street Journal, they want crop reports, they want OPEC rumors, they want Greenspan's shoe size - they believe all of this extraneous information will help them to make profitable trading decisions. And when they make a decision, 99 times out of a 100 it is to buy and hold, hoping that the market will go one way if they just hang in there. Hope is not a good trading strategy!

Trend followers, on the other hand, who are technical traders by nature, say enough! The market price is the best source of information about the market direction because the market price is the aggregate vote of everyone. It doesn't matter if the market goes up or down because all you care about is the price. All markets, from stocks and bonds to metals, currencies and commodities can be traded the same because all you need to know is the market price. Trend Followers see the world in trends. Trend followers know that trends will arrive in unpredictable ways going either up or down. Trend followers simply want to be on board to ride those unpredictable trends for profit. Think about it - what else can you really believe in beside the market price? Or, to quote John W. Henry, "The greatest action, the wisest, the best action that you can take in almost any situation is to stay with what is, instead of jumping to conclusions or trying to come up with conclusions. Just pay attention to what is."

Q2: Most new traders hear the "trend is your friend" speech early, but the majority of them never last more than six months. Is trend following really so difficult?

I think most people fail in entrepreneurial ventures, including trend following trading, due to a lack of will and lack of patience. Is trend following difficult? Conceptually, no it is not. But if you can't stick with it, it will be difficult. However, what in life that results in great reward is easy? The harsh reality of today's markets is no different from yesterday or 10 years ago. Whether you are a trader or investor, ultimately you have only yourself to blame for the decisions you make regarding your money. You can make winning decisions or losing decisions - it's up to you.

If you're a trend follower, you make your decisions based on the market price. If the trend is up, it's a buying opportunity. If the trend is down, it's a selling opportunity or a time to go short opportunity. The market is a brutal place and you must be prepared for ups and downs in your account, including drawdowns and recoveries. You never bet against the trend. Sound hard? Well, great trading is hard!

Q3: Explain some of your market concepts and trading ideas.

So many people get into arcane technical analysis. The great traders don't do that, and neither do I. Trading - the way you enter and exit a market - could really be anything. The trend-followers I write about in my book have a fairly specific strategy. First, they select a portfolio and the markets they're going to track. Then they wait to see if a market starts to move. And if it does, either up or down, then a trend-follower will take an initial long or short position, depending on the direction of the market. The age-old market wisdom is that you're going to run with that position for as long as it goes in your favor. You're not going to guess, or predict, or forecast the direction. You don't know why the market is going up. And frankly, I haven't met a great trend-follower yet who really cares why the market's moving. He just says, "My #1 goal is to get on these moving markets and have risk management so I know that if the market goes against me, I know where and when to exit." That frame of thinking might be the big difference. Trend traders always know what their loss point is. They don't know what the upside is going to be, but they know what the downside is. They're risk managers.

Q4: What are the essential qualities of a new forming trend?

I keep getting asked that question. I think it's phrased incorrectly, because what you're really looking for is more like wildcatting for oil. You drill a bunch of oil wells, and seven out of 10 of them are going to be failures, but three of them will be gushers. The idea is not really about picking or measuring a trend, it's to know the markets that you're following, and know when you're going to enter and exit.

A good example of entry is the age-old break-out. You're looking for a market that has momentum, or a market that's moving up or down. When you find it, you're going to get in. But when do you want to get out? Trend-followers never get in at the exact bottom if they're going long, and they'll never get out at the exact top. A typical trend-follower will get in late and get out after the market has peaked. He rides that trend straight up and doesn't know he's going to get out until it's going the other way. That's the confirming signal to a trend-follower. He's not trying to fight the process, or over think it or over rationalize it. The trend-follower just says, "If it's going up, I'm long. And when it starts to go down, I'm getting out. Perhaps I'll go short." Even more specifically, strong breakouts to new highs or lows. Don't make it much more complicated than that. And of course, a breakout alone does not mean the trend will continue. You can never know you have had a great trend until it is over.

Q5: Where does the psychological element come into play?

It's not the genius of a trend following system that makes them wealthy. It's their self-discipline, willingness to be responsible for what they do, and their hard work. Trend Following rules are the easy part. It's playing by them that is so difficult for many. Frankly it all comes down to defining what you really want. Most people don't want to become rich, they just want to be rich. That's no definition. That's a dream. To become anything you need entrepreneurial zeal, you need passion. But I believe there are a number of key determinants:

- Lack of discipline: Traders are often lazy when it comes to the education needed to trade successfully.
- Impatience: Traders often have an insatiable need for action.
- No objectivity: Traders tend not to cut our losses fast enough. We marry our positions.
- Greed: Traders often want quick profits.
- Refusal to accept the truth: Traders often do not want to believe that the only truth is price.
- Impulsive behavior: Traders often jump into the markets based on a story in the morning paper or on MSNBC.
- Inability to stay in the present: Traders often spend time thinking about how they are going to spend their profits or regretting mistakes they made in the past.
- Avoiding false parallels: Traders often look for patterns from the past that will enable them to predict what will happen in the future.

The quote by Carl Sagan, "It is far better to grasp the universe as it really is than to persist in the delusion, however satisfying and reassuring", is a great reminder of what it takes for trend following success.

6,362 posts
msg #48042
Ignore TheRumpledOne
11/18/2006 5:51:33 PM

10 questions on Trend Following
By Michael Covel
April 7, 2006 4:00 PM ET

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.

6,362 posts
msg #48043
Ignore TheRumpledOne
11/18/2006 5:54:25 PM

Trend Following: How Great Traders Make Millions in Up or Down Markets

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