Trend Following and the Small Trader

I put this site about a year ago to educate people interested in the financial markets about the concept of trend following.  In my mind, trend following is a term that is used a bit loosely to simply describe an approach to trading all financial instruments.  Most people consider the entry and exit signals of a trend following system as the full description of what trend following is all about.

However, from my point of view, trend following goes well beyond simply trying to capture trends of various duration.  Trend following is best applied to the futures markets because you can then set a specific portfolio of markets, and trade them with specific rules for entries and exits, and for how many contracts will be traded for each trade.  What you end up with is a systematic approach to trading that in the long run will help you build wealth.

Most people view trend following more from the approach Nicholas Darvas applied in the stock market back in the 1950′s.  As a result of his success, he wrote a book called “How I Made $2 Million In The Stock Market.”  Darvas put together a strategy that allowed him to capture a few big moves in a handful of stocks, and he placed huge bets.  This was a similar approach undertaken by famed trader Jesse Livermore, which is why he ended up bankrupt on more than one occasion.

Ultimately, that approach is just like gambling, and that is not what trend following is really about.  The professional approach to trend following is one that attempts to mimic a casino.  The casino has a small edge over the gambler, which allows it to make money over a long period of time.  Occasionally, the gambler hits it big, but over time, since he doesn’t have a long term edge, he gives back his winnings.

My point is this…if you are a small trader with less than $50,000 in your futures trading account, it is difficult to trade a trend following approach without gambling.  The fact is, starting with such a small account lowers the odds of your success.  You really must get lucky and hope to avoid a losing streak.  It doesn’t matter what approach you use, ultimately, with each individual trade, you have a less than a 50% chance of being profitable.

Remember, in the futures markets, for every trade you make, there is a trader taking the opposite position.  One of you will be right, but both of you pay a commission, and you might also experience execution slippage.  Even if your strategy ends up with over 50% winners in the long run (not likely with a trend following system), on each individual trade, you are still flipping a coin.

With that in mind, it comes down to money management.  If you are betting too much on each individual trade, your risk of ruin rises dramatically.  Conversely, if you are betting too little per trade, you are not allowing yourself to fully capitalize on the big trends when they occur.

So what does this all mean for the small trader who has less than $50,000 in risk capital?  It basically means you are gambling, because you don’t have the ability to spread out your bets enough to reduce your risk, and therefore, lower your risk of ruin.

Consider the following examples. One of the best trends of 2014 has been the Feeder Cattle market.  Check out the chart below.

FeedercattleJuly2014 Trend Following and the Small Trader

This is a continuation chart, and doesn’t represent actual prices, as it is a back adjusted price chart.  However, it captures the gist of the move in this market.  From early January to the peak in July, this market was up over 20%, and that translates to about $20,000 per contract.  However, let’s examine the chart prior to when the market really started to move in late April.

Feedercattle2013 2014 Trend Following and the Small Trader

On this chart, I have labled the 20 day breakouts in both directions leading up to the successful breakout.  One of the popular trading systems known in the public domain is Turtle System I, which buys and sells 20 day breakouts, with a 10 day trailing exit, and an initial stop loss of 2 x average true range.  You can see that there several false breakouts leading to the successful breakout at point 4, but even that breakout would’ve resulted in a loss due to the initial stop loss.  The average true range at the time of that breakout was about 1.25, so the initial stop loss would be 2.5 points below the breakout point, which was 176.70.  The market hit a low of 173.675 just a few days after this breakout.

So, it is not until the February 13 breakout in this market that a nice breakout occurs that does not get stopped out.  The average true range leading into the four false breakouts ranged from about 1.2 to 1.4.  Therefore, the average loss when employing this stop loss on these four trades was somewhere around 2.5 points, which equates to $1,250.  In other words, a trader would’ve lost $5,000 plus commissions on these four trades.

 

FeedercattleexitJuly2014 Trend Following and the Small Trader

Finally, Feeder Cattle makes a 10 day low on July 11 at around the 210.00 level.  After the entry of the last trade in February, and the need to roll the position from the May contract to the August contract, this results in a profit of over $15,000 after commissions.

Keep in mind, these are not actual trades that have occurred, but are plausible trades based upon Turtle Trading System I.

So, herein lies the dilemma for the small trader.  When you trade a portfolio of markets with a systematic approach, you can expect losing streaks.  In this case, there were at least four losing trades before the first successful breakout.  If you trade multiple markets, you will have longer losing streaks, and you can’t expect that after a losing streak you will experience a windfall trade such as this move in Feeder Cattle.   You should expect a losing streak of 10 or more trades to occur at any given time, and you should expect to lose money in most of the markets you trade each year.

Consider doing the coin flip drill.  Flip a coin 100 times and mark down the result each time.  You will note many instances where you flip heads or tails several times in a row or more.  When you are trading multiple markets, you are essentially doing this coin flip drill at any time.  In the world of trading, you must anticipate the worst of outcomes, and prepare for them as best and possible so you can preserve capital for the times where you may hit a winning streak.

With this in mind, what can you do as a small trader?  First you must develop the mindset that no matter how you trade, you are going to experience losses.  This will be the case whether you day trade, swing trade or employ a trend following approach.

You must then determine whether you have the patience for trend following.  If this is the way you want to go, then do yourself a favor and conduct as much research as you can, and consider pooling your capital with friends and family to spread around the risk.

If you want to learn more, visit The Futures Trading Academy to learn about our Trend Following Course.   You can find it here

Trading Futures and options involves a significant risk of loss. You should consider carefully whether futures or options are appropriate to your financial situation.

 

Trend Following Report Card – Mid Year 2014

So far in 2014, there has been a mixed bag among trend followers through the first six months.  Performance returns among a representative group of trend followers ranges from down high single digits to around positive 5%.  Based on these returns, it appears that most trend followers are again not taking advantage of the moves we’ve seen in the U.S. stock market as well as in the European interest rate markets.  In the commodity markets, we’ve seen huge moves in the meats, but these are not generally liquid enough for the larger money managers to trade.

With that said, many of the mid-sized commodity trading advisors (CTAs) with assets from $25 million to $200 million are generally not performing all that well, as most still seem to be employing medium term, breakout type strategies that tend to be heavily weighted toward commodities and currencies.  The currency markets have been awful for these traders over the last five years, and 2014 is certainly no exception.  Have a look at the chart of the Euro below.

Euro2014 Trend Following Report Card   Mid Year 2014

Euro Currecny 2014

As you can see, this market has been plagued by one false breakout after another, in both directions as it has stayed within an unusually narrow trading range.

Other major liquid markets such as Crude Oil and Gold have experienced similar such trading conditions.  Given that these are highly liquid markets that are attractive to most CTAs, they have simply added to the frustration of these money managers as 2014 evolves into another mediocre year of performance.

The bottom line is that a multi-strategy approach is likely the best approach for any investor in search of solid returns in the futures markets.  To learn more about how to develop your own multi-strategy trend following program, consider the trend following course available at The Futures Trading Academy.  You can find it here

Trading Futures and options involves a significant risk of loss. You should consider carefully whether futures or options are appropriate to your financial situation.

 

Testing The Turtle Trading System Part 3

This is the final video in our series dealing with the Turtle Trading System.  In this video, we test System 3, which is a hybrid between systems 1 and 2.

Trading Futures and options involves a significant risk of loss. You should consider carefully whether futures or options are appropriate to your financial situation.

HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS

 

Testing Turtle System 2

In this video we test Turtle System 2, which involves buying and selling a 55 day breakout, a 2N hard stop loss, and 20 day trailing stop.  Check it out.

Trading Futures and options involves a significant risk of loss. You should consider carefully whether futures or options are appropriate to your financial situation.

HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS

Testing Turtle System 1

Check out the video below regarding testing of Turtle System 1.

HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS

Trend Following is Not A Get Rich Quick Scheme

Probably the vast majority of people who turn to the futures markets do so because of the potential to make a lot of money in a short period of time.  This potential is inherent in the amount of leverage available with futures contracts.  However, the risk of losing all of your money is just as high, and most people end up unprofitable in the long run.

After losing most of their money in their first attempt at trading futures, many people turn to reading all they can about the futures markets, and they may even buy the latest and greatest trading system for $5,000 or more with the hope of turning their $10,000 account into a cool million within a couple years.

Among these trading systems and approaches sold to the public is the concept of trend following.  Traders will read all about how such people as Richard Dennis and Ed Seykota made huge fortunes decades ago in the futures markets simply by employing a trend following approach.  Most of the successful commodity trading advisors (CTAs) also employ a trend following approach.

However, if you do your due diligence, you will find that trend following is a difficult approach for most individuals to employ because most of the trades end up as losing trades, and the drawdowns can be steep.  CTAs who employ a trend following approach are VERY happy to achieve a compound annual return of 20%, and are willing to accept a drawdown of 40% to achieve those returns.

With that in mind, trend following in the futures markets should be viewed simply as an investment opportunity.  Most of the people who have built considerable wealth in the business of trading have NOT done so by simply trading their own money.  Most also have an income associated with the business, such as a CTA, broker, etc.  They’ve built a business by providing excellent advice, service or money management, and this allowed them to simply compound the gains in their trading portfolio over a significant period of time.

Before you spend that sizable chunk of money on a trading system or advisory service, make sure you are grounded in reality.  Trend following, and futures trading in general, are not get rich quick schemes.

Trend Followers Likely Enjoyed Rebound in April

Most trend following traders likely enjoyed a rebound in April, after a somewhat weak March.  The rally in global equity markets has led the way, while some commodity markets have also exhibited some strength.

So far, 2014 has been a topsy turvy year.  After a weak start in January, trend followers rebounded significantly in February, only to give back some of those gains in March.

While it appears that global equity markets are poised to break to new highs, May tends to be a more difficult month on a seasonal basis for U.S. equities.  Also, given that the Fed continues to taper, the environment for stocks should also be slightly more difficult.  A sizable gain in jobs created with the government’s employment report due out tomorrow may shed more on future Fed policy.

With this in mind, trend followers should not be too surprised by any major reversals in equities.

 

 

Trading For a Living Revisited

Over the past month I’ve conducted a bit of an experiment at my other web site, TheFuturesTradingAcademy.com by providing a few individuals some intensive training about trading futures.  The individuals involved were all very different, and from different parts of the world.  Therefore, I gained a pretty good perspective of how most people view the profession of trading.

First of all, I came to realize that most people have the idea that there are a lot of people out there who are living off of their profits from trading, whether the instrument of choice is stocks, futures, options, forex, etc.  I believe they get this idea from the trading publications out there and the trading forums.

But ask yourself these questions…1) how much money do you need to make to pay your bills.  The median household income in the United States is somewhere around $50,000.  With that in mind, let’s just work with that figure. 2) If you need to make $50,000 annually to pay your bills, what size trading account do you need to achieve that goal?  Many traders seem to think no more than $50,000.  Therefore, this implies that you need to make a 100% annual return, and it better be very consistent, because your bills are due every month.  3) If someone is indeed trading for a living and really building a sizable fortune, why would they bother participating in some online trading forum?  Ego?  Or, are they just talking a good game?

But, how many professionals actually make 100% returns every year?  Check out the performance of any hedge fund, large or small, or registered investment advisor, etc, and NONE make 100% returns every year.  Occasionally, a small fund will make that return in a given year, but not year after year.

THE VERY BEST OF HEDGE FUNDS AND COMMODITY TRADING ADVISORS ARE VERY HAPPY WITH 20% ANNUAL RETURNS.  Short term trading funds will accept a maximum drawdown of 15% to 20% in order to achieve those returns.  Once they reach a certain size in assets, few are able to achieve that goal consistently.  The best trend following CTAs are content with a maximum drawdown of twice their compound annual growth rate over the long run.

Most people don’t seem to accept the fact that virtually every wealthy trader has NOT achieved that wealth by trading their own money alone.  They realized early in their careers that they could make a whole lot more money, with LESS risk by managing money for clients, in addition to their own.  This provides them with steady income through a management fee, and the ability to hit it big with an incentive fee in years where the markets are favorable.

The second thing I noticed is that most people want to focus on short term trading in order to limit drawdowns.  Realistically, most people simply can’t trade well with shorter term strategies because they aren’t able to monitor the markets all day long.  Furthermore, this is also where most of the hedge funds are concentrating their attention these days.  Virtually every big trading firm out there is hiring quantitative analysts and software engineers to help build high frequency trading programs.  Do you really think you can compete with them?

Another thing I realized was that most people are suffering from information overload.  They have knowledge of a variety of strategies, but no real focus or trading plan to implement them.  Most are still looking for some holy grail trading strategy, and firmly believe that the big successful trading firms truly do have some magic formula.

Most people seem unwilling to take the time, and accept the expense, to conduct their own trading research.  They want to spend some money and be given a trading system that will provide them with riches.

Consider this…the average cost of higher education at a private university is now over $40,000 per year, or $160,000 for a four year degree.  At an Ivy League school you are closer to $250,000.  Why on earth would you possibly think you could spend $100, $500, or even $5,000 and suddenly have the ability to trade for a living?

My goal is to help people realize how difficult trading really is, and to avoid many of the mistakes most of us have already made in this business.  With that said, trading and investing is one way for the average person to build wealth over a long period of time, if done right.

Just food for thought.

Own your trading strategy

As I often do, I equate traders to golfers.  The best traders do things in their own way, and are willing to stick with that plan through thick and thin, with some occasional tinkering.  Professional golfers, with the exception of Tiger Woods, are willing to stick with what they do best, and seek only fine tuning now and then.  Tiger has changed his swing four times, and it is clear that he has not exactly improved with each change.  But, I digress.

Most unsuccessful traders will move from one strategy to the next because they never rely on their OWN homework.  They are always relying on tips from other traders, or strategies and systems developed by someone else.  Poor golfers are always moving from one golf tip to another, one training device to another, and one swing coach to another, because they are unwilling to accept the fact that it takes hard work, and learning about their own strengths and weaknesses, to develop a golf game that works for them.

I can’t think of a single successful trader who simply copied what someone else was doing.  Sure, they learn a thing or two from other traders, but then they ultimately develop a trading approach that suits themselves.

This is why it makes no sense to simply learn the Turtle rules and start trading today.  If you don’t conduct your own research, and understand that losing streaks and drawdowns are inevitable with any system, then why would you think you would have the confidence to stick with a system through a losing streak?  Second guessing is human nature.

This is the reason I created The Futures Trading Academy.  I believe that most people could use a little guidance in developing their own trading approach.  I present a number of strategies from day trading to trend following, and develop a rapport with each individual I work with.  Our goal is to develop a program that works for them, not just regurgitate material that is already out in the public domain.

If you want to learn more about that program, I encourage you to visit The Futures Trading Academy.  Otherwise, at the very least, go through the process like Ben Hogan did and “dig it out of the dirt.”  Do the necessary research and testing to develop your OWN trading approach.  It takes a lot of hard work, but you will be better off for it in the long run.

The Fascination With The Turtle Trading System

The single most popular post on this website, by far, is the one titled “Is The Turtle Trading System Dead?”  There is a clear fascination with the Turtles and the trading system they were taught by Richard Dennis and William Eckhardt.

There is also a clear fascination with the trading approach known as Trend Following.  Since the Turtle Trading System is a trend following approach, these two ideas are inexplicably linked.

So, the question that should be asked is…should traders still be fascinated with this system and trend following in general?  My answer is a resounding NO!

It’s been over 25 years since the Turtle program ended, and just over twenty years since Russell Sands and others began to capitalize on the legend.  The futures markets have evolved dramatically since then.

Consider that back in the late 1980′s, total assets under management in the managed futures universe was well under $50 billion.  In fact, it was probably closer to $10 billion.  Now, the figure is upwards of $300 billion.

Also, the vast majority of the money managed by commodity trading advisors is done so with a trend following approach.

Let’s look back on the 1980′s.  At the start of the decade, interest rates were as high as 20%, as the Fed began aggressively tightening in order to reign in inflation.  There were huge moves in futures markets in every sector, and the currencies in particular made huge swings.

Remember, this was also prior to the substantial globalization in the markets.  Back then, if there was a supply disruption in a crop such as soybeans, prices would move dramatically, because we didn’t have nearly the amount of global trade that we do now.  Nowadays, a supply issue in one part of the world can be offset from another part of the world…in many markets.

Nowadays, we also have far more active central banks.  Back prior to globalization, if a country’s economy began to struggle, they would simply print money, which would lead to hyperinflation and huge movements in currencies and interest rates.  Now, central banks and governments are far more wary of such policies, and these financial markets are linked more closely.

The end result of all this is that while trends do still occur, they tend to be more difficult to exploit.  We also have the issue of trading firms that are far more focused on shorter term movements and market inefficiencies.  As a result, there is more daily volatility, but not more annual volatility.  In other words, the price action is choppier, which has absolutely killed the breakout style traders such as the Turtles.

Therefore, it has become necessary for traders to adapt.  I’ve noted that Jerry Parker at Chesapeake Capital seems to have done this.  After seeing a substantial decline in assets under management, likely due to mediocre performance, Chesapeake made a nice comeback in 2013 with a 25% return in its Diversified program.  Also, Chesapeake’s single stock futures trading program returned 65% in 2013.

Meanwhile, other former Turtle traders and their mentor (Eckhardt), continued to struggle, and assets under management have declined sharply, according to a review of reports at Autumngold.com.  In fact, JPD Enterprises, run by former Turtle James DiMaria, closed its doors in October.  The other former Turtles were flat to down double digits in 2013.

With all this in mind, the fascination with the Turtle Trading System really needs to come to an end.  Should a new or potential futures trader learn the system?  Absolutely.  It should be part of any trader’s required education.  But, the bottom line is that times have changed, and the competition has increased dramatically since the days when the system was originally taught.

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