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Trend Following Portfolio Selection Question

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Thanks for the audio links, Michael. I’ve listened to these (about to listen to the excerpt of your audiobook “TurtleTrader”) and they are worth a re-hear to pick up morsels I missed the first time through. At 65, it’s increasingly important for me to do that.

I have a critically important trading question, one that has dogged me for over 20 years, an answer to which I’ve not found, and am hoping TF traders have a fairly standard approach to addressing. What happens when 44 stocks pop up on a TF screen one day? Background follows:

I threw the Trend Following algorithm located in the Appendix (or was it Chap 12?) of your book “Trend Following”, just for fun, into ToS. Not hard to screen, and I limited my universe to stocks and ETFs with Regular and Weekly Options—just to ensure sufficient liquidity of the securities traded. I also built its mirror for bear trend following.

I wanted to see how many stocks would pop up on the screen. For a number of days, I’d see a couple, maybe one, where the volume of the candidate stock also exceeded its five-day SMA on the day it popped up; I’m tracking each daily list in its entirety for about 60 days to see if above-average volume is an effective 2nd-round screen.

I’m paper trading these for now and for at least two more months while I work the kinks out of my understanding of the choice of 39-period (days in my case) High of Highs and the 13-day TS. I’m comfortable with this kind of strategy—catch some fresh blood or a renewed uptrend, catch a long-term climber, and 13 is one of Tom DeMark’s Sacred Numbers (just kidding—I respect his work a lot). Also built the mirror screen for shorting. I know, I could wind up holding a position for 12 times that length, but the first 60 days are enough for me to start noticing some tendencies. I’m also a fan of backtesting to exclude stocks that don’t often follow through on a High of Highs signal, but I haven’t done so yet for this experiment.

Well, on Friday my old nemesis appeared—about 44 stocks had passed my Bear TF initial screen. No way I would buy 44 new puts—my balances aren’t high enough to sustain such a thing. However, any screen that pushes that many candidates through are usually useless to me, as I have a knack for picking the worst 5 out of a pile of 40 candidates. The Worst 5. I’ve not tried a simple random sample of the candidates, nor have I tried to backtest each candidate yet.

If you have a podcast that addresses this question, I’ll be glad to listen to it. Thanks for your time.

Sincerely,
[Name]

Great question. It is an issue that I have helped clients with for over a decade (www.trendfollowing.com/products).

Trend following at its essence has 5 issues:

1. What market do you buy or sell at any time?
2. How much of a market do you buy or sell at any time?
3. When do you buy or sell a market?
4. When do you get out of a losing position?
5. When do you get out of a winning position?

Said another way (Bill Eckhardt inspired):

1. What is the state of the market?
2. What is the volatility of the market?
3. What is the equity being traded?
4. What is the system or the trading orientation?
5. What is the risk aversion of the trader or client?

To your question, its #1. Narrowing the portfolio. One of the keys with trend following is to narrow the portfolio so you don’t trade everything and if there are competing signals that you have a ranking system.

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