The Trend
People ask, "what is a trend?" One of the best discussions I have seen on the subject comes from top trend follower and one of my mentors Ed Seykota:
"A trend is a general drift or tendency in a set of data. All measurements of trend involve taking a current reading and a historical reading and comparing them. If the current reading is higher than the historical reading, we have an up-trend. If lower, we have a down-trend. In the improbable event of an exact match, we have a sideways trend. The direction of the trend depends upon the method we use to perform the comparison. Real instruments fluctuate minute-to-minute, day-to-day and year-to-year. We have, therefore an enormous supply of historical points to use to determine trend. As such, we can determine as many instances of trend as we please, in any direction that we please. There is no such thing as the trend; there are countless trends, depending on the method we use to determine a trend. People typically pick a method for determining trend that fits with their current positions and/or view of the market. All methods of defining trends compare various combinations of historical price points. All trends are historical, none are in the present. There is no way to determine the current trend, or even define what current trend might mean; we can only determine historical trends. The only way to measure a now-trend (one entirely in the moment of now) would be to take two points, both in the now and compute their difference. Motion, velocity and trend do not exist in the now. They do not appear in snapshots. Trend does not exist in the now and the phrase, "the trend" has no inherent meaning. When we speak of trends, we are speaking, necessarily, from some or another view of history. There is no such thing as a current trend. When we speak of trends we are necessarily projecting our own definitions. With that in mind, we can proceed to examine ways to define, compute and use trends."
Well stated. Our instruction takes this to the level of detail needed to become a successful trend following trader.
Top Reasons for Trend Following Investing
Profit in Up and Down Markets:
Trend following doesn't swear an allegiance to a bull or bear market. It follows trends to the end. No matter how ridiculous trends might appear early and no matter how insanely extended they might appear at the end, follow trends. Why? Because they always go further than anyone expects! Ignore momentum at your peril.
No More Buy and Hold, Analysts or News:
Trend following decision-making doesn't involve discretion, guesses, 'gut' feels or hunches. It's not day trading or buy and hold (hope). It doesn't involve passive indexing, in and out trading or fundamental analysis. No more 24-hour news cycles, daily turbulence or sensational hype. No black boxes or magic formulas either. Hope is the most addictive drug. Let go of the Holy Grails. The good news? Complete beginners can learn trend following.
No Prediction:
Trends exist everywhere, always coming and always going. Whether fashion, business or whatever, we all want to find trends and ride them as far as they can go. Markets are no different: they trend up and they trend down. That said, no one can predict a market trend, you can only react to them! Trend following never anticipates the beginning or end of a trend. It only acts when the trend changes! However, there is no need to figure out 'why' a market is trending -- just follow it. You don't need to understand electricity to use it!
The Big Money of Letting Profits Run:
Trend following aims to compound absolute returns. It doesn't shoot for 'average.' Do you really want to be exactly like your neighbor? The goal is to make the big returns, not generate passbook savings returns. Trend following also has the unique ability to lie and wait for 'targets of opportunity.' This means 'outlier' events (read: unpredictable surprises like the 2008 market crash) can make you huge money.
No Traditional Diversification:
Trend following is not restricted to any single market or instrument. A focus on 'price action' allows trend following to be applied to an exceptionally large variety of markets. Price is the one thing that all markets have in common. That means a system for treasury bonds will work on the Euro too. And if you switch it over to coffee, something totally different than treasury bonds, it still works. Trend following is robust! But don't expect the 'tape' to lecture you. You have to trust your buy and sell signals and follow all rules.
No Government Reliance:
Forget Social Security, bailouts, stimulus plans and roads to nowhere. Those won't help you to make money, but they might help you to lose money! When the Fed takes the 'training wheels' off the economy will you be ready to mint cash or will you just sit there and take it again? If your portfolio is grounded in sound principles you can win, but the government has nothing to do with sound anything!
Takes Advantage of Mass Psychology:
Markets, which are always changing, are only our subjective expectations reflected objectively. Interestingly, people's reactions to change always remain the same (i.e., they bet wrong as a group). Trend following takes advantage of 'panicky sheep' behavior to make money. How? Strict discipline minimizes behavioral biases. It solves our eagerness to realize gains and reluctance to crystallize losses. Let's face it too many people believe what pleases them and social conformity means that even if the group is wrong, we go along. Most behaviors are simply driven by the impulsive moment of now. They aren't purposeful, thought-out choices. Trend following wins because of that.
Scientific Approach to Trading:
Trend following doesn't require a belief, but rather it relies on unwavering principles proven over decades. It has a defined edge just like the MIT card counting team that beat Vegas casinos (read: mathematical game theory from the movie 'A Beautiful Mind'). Be the casino and not the hapless player. How? Trend following uses hard rules rooted in numbers (think process not outcome). And remember, frequency of correctness does not matter, the magnitude of correctness matters. 'Winning percentage' means zilch. How much time will trend following take? No staring at the screen drinking 'Red Bulls'! Once you are setup, minutes a day is all you need when you approach trading like an engineer.
Strong Historical Performance in Crisis Periods:
Trend following prepares for the worst at all times. It is adaptable to differing climates and environments performing best during periods of rising volatility and uncertainty. Guess what? The unknown will happen again. Are you ready? You have to be able to ride the bucking bronco while also riding the storm out. That said, the day you have to do something, you are screwed. Trend following, like a lion waiting to strike wounded prey, is very patient.
Risk Management is Top Priority:
Trend following always has defined exit protocols to control 'injury' to your account. Stop losses and proper leverage usage are standard practice. Trend following also has low to negative correlations with most other investment opportunities. It eliminates exposure to groupthink and toxic assets. Eliminating exposure is a winning move whereas hedging can actually increase your exposure! Trend following is the best protection for when bubbles pop and everyone starts running for cover.
No Government Reliance:
Forget Social Security, bailouts, stimulus plans and roads to nowhere. Those won't help you to make money, but they might help you to lose money. When the Fed takes the 'training wheels' off the economy where will you be? If your portfolio is grounded in sound principles you can win, but the government has nothing to do with anything.
