Mike Hogan penned an article titled ‘Making the Trend Your Friend‘ in today’s Barrons. An excerpt:
BUY-AND-HOLD INVESTING is a loser, says Michael Covel, founder of Trend Following, one of several Websites devoted to the trading strategy of the same name.
“How many more decades can you go with negative returns?” he asks, referring to the disappointing aughts (www.trendfollowing.com). The unofficial chronicler of the 25-year-old active investing strategy, Covel claims that leading practitioners of trend following, like Boston Red Sox owner John William Henry, have collectively logged a 17.56% average annual return since 1984 compared with 7.37% for the Standard & Poor’s 500.
Trend following is grounded in the notion that a stock or sector in motion tends to stay in motion—until it stops. “Markets that break out are more likely to continue than to reverse direction,” maintains Covel. It’s equally applicable to short and long trades and to any class of asset—stocks, futures, currencies—with typical holding periods of a few weeks.
Trend following is similar to momentum investing, except that devotees studiously avoid using company fundamentals like revenue growth or positive earnings surprises as trade signals. The focus is entirely on price movement—although trend followers aren’t that enamored of charting or technical analysis, either. When a trend starts, most technical indicators turn in the same direction, says Covel.
THE KEY DIFFERENCE between trend following and most investment strategies is the lack of crystal-ball gazing. Trend followers make no attempt to forecast a trend’s duration, magnitude or key inflection points. Entry and exit triggers are decided at entry, and trend followers often arrive late to the party.
Its “buy high, sell higher” orientation smacks of the bigger-foolism that has tripped up so many investors, large and small. But trend followers don’t blindly chase bubbles. Their systems try to take the emotion out of investing through rules-based decisions, back-testing of trade theses and strict risk management.
A portfolio is usually spread across a dozen or more (hopefully) noncorrelated assets with tight trailing stops, which can be 2% or less below entry price. That means a high percentage of holdings can get stopped out in the search for a few home runs. Investors need a pre-defined fund allocation strategy that can withstand a losing streak.
“As many as 60% of initial bets will be wrong,” says Covel, “The biggest impediment to success is fear of failure.”
Covel operates several sites that explain the strategy, including michaelcovel.com and turtletrader.com. They are supported by the sale of books, CD-ROMs and seminars, but also offer considerable free content (www.trendfollowing.com/resources.html).