Trend Following StocksIf you are new to trading, and interested in employing a trend following strategy, avoid trading futures and focus on trading stocks.

The fact of the matter is that systematic trend following just doesn’t work in the futures markets like it used to.  The players in the game are far more sophisticated, and nice intermediate trend moves are far less common.

The individual trader also just doesn’t have enough capital to deploy a trend following strategy in the futures markets, even if they want to employ discretion.

Therefore, it’s a good idea to focus on trading stocks instead.  Let’s have a look a the pros and cons.

Why trade stocks as a trend follower?

The primary benefit to trading stocks is the sheer number of opportunities.  There are thousands of stocks to choose from (this will also be a con, but we’ll get to that later).  At any given time, even during bear markets, there are at least a few stocks that are going up.

Trading stocks also requires far less capital.  This is due primarily to the lack of leverage in trading stocks compared to trading futures.  In the futures markets, you can deploy up to 20:1 leverage at times.

While that means you can make a lot of money in a short period of time, it usually means that you will lose money more quickly.  Also, the number of liquid futures markets that offer mini and micro sized contracts limits the opportunities substantially

In the stock market, if you are holding positions overnight, you can generally only employ leverage up to 2:1.  So, if you have a $10,000 margin trading account, you can hold positions worth a total of $20,000.  Also, since you are trading shares and not contracts, you can control the amount of risk in a position more easily when trading a small account.

Learning how to employ a trend following system is quite difficult.  You have to learn to cut your losses and ride winners.  When you are able to control risk more easily, it is a bit easier to let profits run.  The stock market is a good training ground for learning to trade with discipline.

Stock trends also tend to last longer than in the futures markets, and by controlling your risk, your account equity won’t fluctuate as much as it will in the futures markets.

So what are the cons in trading stocks?

Well, just as it is an advantage, the sheer number of stocks available to trade can be overwhelming.  Therefore, without a good platform or way to scan the entire stock market quickly, it can be very difficult to find the right stocks to trade.

However, the biggest hurdle that stock traders face is that you can’t use your open trade profits to add new positions.  In other words, if you have a $10,000 margin account, and you already own $20,000 worth of stock, and your positions are worth $25,000, you can’t use that $5,000 in open trade profits to add to an existing position or to enter a new position.  You have to sell one of your positions first.

In the futures markets, this is not the case.  If you buy a gold contract at $1,300 and it goes up to $1,400, you now have $10,000 in open trade profits.  You also now have an additional $10,000 in which to deploy in the gold market, or any other market.  Keep in mind though, if that position in gold turns against you, and you have too many other positions, you can easily receive a margin call.

While trading shares in individual companies, you simply don’t have the leverage available that you do in the futures markets.  Therefore, it can take more time for your account to grow.

Lastly, when trading stocks, bad news for a company can result in substantial losses that you otherwise may not experience in the futures markets.  I’ve seen stocks drop by 50% in a single day due to a bad earnings report, or other adverse news item.  I’ve even seen this occur while a stock is still trading in an uptrend.  This is why it is so key for traders to limit risk as much as possible while still allowing for significant returns to occur if the markets move in their favor.

Final Thoughts

Over the years, I’ve focuses most of my attention on developing trend following systems for the futures markets.  However, with all of the central bank intervention and the continued increase in the sophistication of many traders involved the futures markets, they are becoming more difficult to trade.  It now requires some sort of destabilizing event for any sort of major trend to occur, and the trends tend to be more choppy than they once were.

With this in mind, new and intermediate traders interested in employing a trend following approach to trading should start out in the stock market.  Once they’ve enjoyed some success for a few years, they can they move on to the futures markets.

I’ve started a new site where I teach everything I’ve ever learned about trading.  Consider heading on over to The College of Trading and sign up for my free trading course.  Hope to see you there!