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Trend Following FAQs: #1

The View on Trading Software
The View on Trading Software

My main frequently asked questions page is here, but this is another page of questions in from readers:

Q: A friend who is way more successful at trading than I, sent me a link to listen to your podcasts. I have invested more than I care to mention here, on investment training, still not showing ANY positive return. Can you help? Hope so.
A: Yes.

Q: I have totally enjoyed listening to your podcasts. When I ran across your website, (I would have liked it to have been years ago) I started listening to your podcasts. Started on the oldest and currently listening to #83 with the great Tom Basso. So I have a long ways to go. When I first started listening I thought what a great idea. I know people are available because years ago before the internet, I spent 30 minutes + on the phone with Mark Faber who was living in Hong Kong at the time. Mark was very easy to talk with and forth coming with information so I applaud you for doing what you have done and are doing. I do have a question. What are the top 3 companies offering either software or services to test various strategies? I have done all of my research by hand due to the fact that I have pretty much come up empty handed as far as a fairly inexpensive and simple to use system. If you have a podcast that covers this just let me know which one and I will listen to that first. Let me know how I can help you.
A: Start here.

Q: Thank you sincerely for sending me the DVD all the way to Germany. I am very thankful for that! I found it amazing to see that you were located in Reston, Virginia, where I was stationed as a German exchange soldier from 1995-2001 and where I graduated from [name] and got my MBA from [name] at Falls Church in Finance. My path then had me travel back to Germany and start working as a bond trader for one of the largest banks over here, which is now Italian. Today I run Credit Sales into Germany, Austria & Switzerland at the second largest [country] bank. I spent twelve hardworking years looking for the right trading approach for me and am now coming full circle back to Reston, VA and you! Thank you for your offer to join you and your firm in properly learning a fully worked out process of trend following all markets. After having spent thousands of dollars on trainings, courses, seminars, worked countless hours on day trading approaches and then spent four years investing my own funds by selling far OTM strangles until a tail risk event hit me hard this year, I came to realize that only a well diversified portfolio of trend following bets in addition to sound money management can be the right approach for me to achieve freedom from having to go to work every day in a few years. I am looking forward to working with you over the next 18-months. What do you need from me, in order to purchase the Flagship Pro Trader please Michael? Thank you again and kind regards from Germany.
A: Thanks for the great feedback. You can order here.

Q: Hello, I am seriously considering purchasing your flagship trading systems course, but I have one very important (to me) question before I do. I gave up work 12 months ago and have spent 8-10 hours per day, mostly 7 days a week, studying trading. I confirmed for myself that trend following was the most profitable, and I also confirmed for myself that all indicators are useless for anything better than 50% accuracy. I have categorically proven to myself that prediction is futile and reacting and following the market is the only real option. So everything you say and seem to teach resonates well with me. I have read your trend following book which I think is the best book I have read on trading specifically. However, I have to disagree with one very important point you voice quite strongly, and before I buy your course I would like you to explain to me the following quote from your website FAQ page: “Day trading is fool’s gold. Our training will be worth millions to you over the course of a lifetime if you simply understand that day trading is a waste of time.” What I don’t understand is that from a technical aspect (if we ignore all fundamentals as you suggest) is that all Trends Charts are identical. If I showed you a one minute chart, a 1 hour chart or a 1 week chart, without any prices (simply the individual bars or candle patterns) you would not be able to tell the difference of time scale. A 1 hour chart will have just as many noticeable and strong trends as would a daily chart. If I am trading with a % risk per trade, the pip values are proportional. If I risk 1% on a trade with a 10 pip stop loss and ride a trend for 100 pips profit on a 1 minute chart, the impact on my account equity will be identical as if I risked 1% on a trade with a 100 pip stop loss and ride the trend for 1000 pips profit on a daily chart. The real difference is I will be able to trade far more often on smaller time frames than if waiting for trends on daily or weekly charts. Obviously I understand if someone is trading $ Billions then they simply can’t trade small time frames because of liquidity issues and getting orders filled. But for people starting out with less than $100,000, it makes no sense to sit there waiting for one trade per month, risking only 1% of my account, when I could be trading daily, using the exact same entry and exit rules. Surely technical analysis by its very nature is completely independent of time? You even state yourself in your book that the instrument is irrelevant because the charts and trends are the same for all markets…we just follow the trend regardless of fundamentals or the instrument. So how does time scale make any difference? I will be able to build my account much faster with exactly the same strategy and risk management if I trade intra-day while my capital is small, and then move up and scale in to trades as and when my trade size increases to where liquidity matters for order filling. I hope this question does not come across as argumentative in any way. I just genuinely don’t understand the logic, and I always need to understand something fully before I just follow blindly or take someone else’s word as fact. If you could help me understand why your way of thinking is correct, and where my logic fails, I would be very grateful and will be ready to purchase your trading course this week. My sincere thanks for you taking the time to read this email and hopefully answer.
A: Great question! Short answer: transaction costs and slippage are killers. Longer answer? I am reposting an earlier question and answer session on the same topic:

Hi Michael, I have been reading and following your website and blog posts for the past several months. I have to say that the information you provide is rare to come across in today’s internet world. The work you’ve done over the past several years has been amazing. I just wanted to introduce myself and ask you a question on which you may be able to shine some light on. Firstly, my name is [blank]. I am currently a student at the University of Toronto in Ontario, Canada. I am in my final year of, what they say, is a prestigious finance program in one of the top universities in the Country (although the quality of information i receive daily is, in my opinion, average at best). I will be graduating in a about 2 months and am one of the few lucky students, in this economy, to have been offered a full-time position post-graduation. In May, i will be starting a job as a junior trader in a prop-trading firm located in [blank]. The firm specializes in futures trading. Although i have been interested in trading and trade on a part-time basis for the past year or so, i am fairly new to the game. The firm is mainly a day-trading firm as many prop-trading firms are. I was wondering how your concept of “Trend-Following” applies to the day trading time frame (that is minutes, hours, etc)? Does this type of strategy only work for longer time frames or has it been successful with traders who use it to day trade? Thank you once again for everything you do. Hope to hear from you soon.

Many issues from transaction costs to a need for superior access and execution are working against you. Ed Seykota once gave some insights on short-term trend trading:

Intraday trading is tough since the moves are not as big as for long-term trading and there is no comparable reduction in transaction cost. In general, short-term trading systems succumb to transaction costs and execution friction. You might simulate your system over historical data and notice how sensitive it is to assumptions about where you get your fills…The shorter the term, the smaller the move. So profit potential decreases with trading frequency. Meanwhile, transaction costs stay the same. To compensate for profit roll-off, short-term traders have to be very good guessers. To improve guessing skills, you can practice dealing cards from a standard deck, one at a time. When you become very good at it you might be able to make money with short term trading.

Seykota was also asked:

I am new to trend following and wish to ask you what your favorite chart is for determining a given market’s trend? Daily, weekly, yearly, hourly?

Seykota responded:

Hmmm…your list seems to lack scaling options for minute, second, and millisecond. If you want to go for the really high-frequency stuff, you might try trading visible light, in the range of one cycle per 10-15 seconds. Trading gamma rays, at around one cycle per 10-20 seconds, requires a lot of expensive instrumentation, whereas you can trade visible light ‘by eye.’ I don’t know of even one short-term trader, however, who claims to show a profit at these frequencies. In general, higher-frequency trading succumbs to declining profit potential against nondeclining transaction costs. You might consider trading a chart with a long enough time scale that transaction costs are a minor factor — something like a daily price chart, going back a year or two.

He is not saying short-term is impossible. There are shorter-term systematic traders who have done quite well (Toby Crabel and Jim Simons, for example). They would agree with Seykota that their style is hard. The shorter you go, the more the need for great execution, fantastic data, and multiple systems. And in closing from Jessie Livermore:

“….the big money [is] not in the individual fluctuations but in the main movements — that is, not in reading the tape, but in sizing up the entire market and its trend.”

Finally, consider an excerpt from Larry Hite taken from his Afterword for my book Trend Following:

Most of the guys that I knew who lost a lot of money actually tended to be more right than wrong. They just lost a lot on a few big losers. I believe that people put too much of a premium on being right. In some ways, it’s one of the drawbacks for people who went to the best schools and always got straight As—they are too used to always being right. It gets back to people and emotions. Everyone is happy to take lots of little winners—it makes them feel good. When their trades go against them, on the other hand, they hold on because they don’t want to accept being wrong. Many times, these trades come back and they are able to capture their small profit. To me, that kind of trading is a little bit like picking up nickels in front of a steamroller.

Thankfully, the markets don’t care about me or you or where we went to school. They don’t care if you’re short or tall. I was never very good in school and I wasn’t a good athlete either. With my background, the way I saw it, I never had any problem with the idea that I could be wrong. So, I have always built in an assumption of wrongness to anything that I do. We now kindly refer to this practice as risk management, but I just wanted to answer the question: “What’s the worst thing that could happen to me?” I never wanted to do anything that could kill me. Knowing that I was not likely to be right that often, I had to trade in a way that would make me a lot of money when I was right and not lose me a lot of money when I was wrong. If that wasn’t enough, it also had to be simple enough for me to understand.

After many years of searching and learning things the hard way, I evolved my own version of trend following. The idea made sense and I had some good examples to follow. Still, I wanted to prove to myself that it worked without betting real money. I had to test what would have happened had I traded that way in the past. These were the early days of computers and we even had to “borrow” time on university computers to test and prove our theories. It was a painstaking task, but it gave me the comfort that I needed. Now, in reading Trend Following, the do-it-yourselfers might argue that having a book that illustrates these same basic principles takes some of the fun out of it.

Actually, Covel, like any good trend follower, has not focused solely on the endpoint. He gives you a deep understanding of the most important part: the path. Unlike so many other books that have been written about investing, Trend Following goes beyond the results to explore the journey of this outstanding group of traders.

For my staff… Covel’s Trend Following is required reading. For my daughters at home, it has finally settled the question I seemed never to have been able to clearly answer myself, “Daddy, what do you do for a living?” This book captures and conveys what so many traders have taken careers and large losses to learn. And lucky for all of us, you don’t have to be Phi Beta Kappa to understand it.

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Trend Following is for beginners, students and pros in all countries. This is not day trading 5-minute bars, prediction or analyzing fundamentals–it’s Trend Following.