I have done trend following in the past but it was not successful. I believe many people had the same experience for me and are quick to denounce trend following does not work. No matter how we hold that opinion, there are enough professionals making money with trend following strategies. Andrew Abraham is one of them. In this book, he showed me the reality of trend following and I realised how wrong my expectations were.
Here are the 3 things I learned from the book
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#1: Compounding realistic profits (not get rich with just one or two trades)
Andrew said some of the best traders he knows, only make an average of 15 percent per year over the long run. This is a realistic return. Most people expect trend following to make them rich in no time and only to be disappointed when they see no profits or worse, lose money.
“trend following is not the only solution to compound money over time, but it is the strategy I adhere to and I have personally been able to compound money over time.”
If you want to increase your profits, you will inevitably increase your drawdowns. There will be a point where your risk of ruin will be too high, and you stand to lose all your capital.
“Think of risk of ruin as bites out of an apple. If you are risking 1 percent of your account on a trade, you get to have 100 bites out of the apple… If you are risking 10 percent of your account, you only get 10 bites out of the apple. I can promise I have had close to 10 trades in a row not work over the years. Basically you risked too much and your trading account is ruined.”
“I have seen traders take on too much risk, enter a severe drawdown, and stop trading. I am personally less concerned about the return on investment and more concerned about how much risk I will have to tolerate to achieve my goals of reasonable returns over time.”
#2 Consecutive losses and large draw downs are unavoidable (you have to keep trading)
In 2010, Andrew experienced 9 consecutive losing trades. In 2011, Andrew experienced 10, then 8, consecutive losing trades! Consecutive losses really tests your conviction about following your trading plan. But you have to keep trading because you do not know when is the next big win that will book the year’s profits.
“The losses were kept small, ranging from -.1 to -1.6 percent. However, losses like this are tough to take. I cannot remember when so many trades did not work. This is the reality and exemplifies why trading can be so hard. At the puke level at which most people would have wanted to quit there was the natural gas trade, which saved some of the year form being a total disaster.”
#3 Profits are not consistent (do not expect profits on a monthly or annual basis)
Trend following does not give you consistent profits. There may be a period, as long as a few years, without making any profits. Andrew recounted his experience of 17 months without any profits! The hard part is to continue trading and follow the plan with discipline.
“Worse than the drawdown is the duration or time period in which you have not made any new money. This is probably what causes traders to either stop trading or start their quest for a new approach. One needs the mental fortitude to continue trading when one has not made money for more than two years. This is reality.”
“That is why I commonly say trend following is a marathon. Too many traders and even investors in focus on short-term results and lose their perspective. I am asked all the time how I did last month or last year. The reality is, that is meaningless. If I had a great month or year, does that mean I will have a great month or year following? Probably not! I am at the mercy of the markets trending.”
Besides talking about the hard truths of trend following, Andrew described two strategies (Trend Breakout and Trend Retracement) and his extensive risk management rules. I will skip them in this post as briefly covering them may risk incomplete understanding and inappropriate implementation of these strategies. I will recommend you to refer the book if you are interested in his methods.
There are a some more useful nuggets of information that I have captured from the book about trend following:
- Trend following is simple but not easy.
- The most important qualities of a successful trend follower are patience and discipline.
- The only certainty is uncertainty.
- There is no holy grail. It is how you think that matters.
- You need to have a variety of markets to choose from. Avoid the volatile ones and only trade markets that are moving.
- Greater returns comes with greater draw downs. (DUNN Capital had a year with 100% gain but it also suffered as much as 70% loss in another year)
- The best time frame is one that matches your time constraints and personality.
- There is a drawdown out there that can make one stop trend following.
Lastly, you can watch a video which Andrew talked about trend following.
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