Gibbons Burke of MarketHistory.com recently opined:
The market serves a valuable function in our economy not often talked about: It provides an efficient mechanism for transferring precious capital from those who are ill-equipped to steward its growth to those who are adept. A variety of market participants provide this service up and down the food chain. The financial markets are voluntary arrangements. No one is compelled to purchase a piece of trading software. No guns are involved in herding investors into seminars. Advisory letters are sent to those who willingly subscribe to them, and may be cancelled at will. Investors who avail themselves of these services without exercising due diligence and taking responsibility for their own actions are the true dangerous lot — they are a danger to themselves. They blame others for their bad decisions and misfortunes; they delude themselves about the true nature of their problem, so the solution remains ever beyond their ken.
I attended a luncheon recently in La Jolla, CA where Paul McCulley of PIMCO spoke to the idea of a “stable disequilibrium” – a unique concept that helps to explain the volatile uncertainty facing traders across the globe. Paul is a great speaker. He could easily be a history professor specializing in the financial markets. I now understand more about the last 50 years of currency markets than I ever expected to know! He of course trades from a fundamental perspective.
Read Paul’s April commentary for greater insight into his “way”:
Download the Adobe PDF commentary.
I have always admired those select few that can really “get” the fundamentals and consistently use them to make positive trading decisions. Paul and PIMCO have long made the “right” moves. But after listening to Paul I kept wondering how viable his way was for most traders? Would most traders ever have the ability to absorb all of the daily fundamentals and make the right entry and exit from the market for profit?
Trend following is a form of technical analysis. However, it is not predictive technical analysis, but rather it is reactive technical analysis. This is key to understand.
Technical analysis must not be predictive or you will lose. Trend following does not involve the use of RSI, Gann, Elliott Wave etc. These types of indicators all purport to predict markets. However, you can’t predict a market, you can only react to it. Trading as a trend follower, for example, is entirely reactive with no prediction. Trend following is comprised of both money management and technical indicators.
Misguided insight from Fidelity.
Indicators Are Not Enough
People get caught up thinking that indicators are “it”. They think indicators are all they need. First and foremost you need a trading system that answers the 5 questions presented in Chapter 10 of the book Trend Following. The list below may have some indicators that are useful in the context of answering the 5 questions that make up a complete trading system, but used alone these indicators are useless.
More on indicators.
More on why entry/exit is not enough.
|+100/-100 Crossover||This is a classic interpretation of CCI. Crossings from above +100 to the downside constitute a short, and crossings from below -100 to the upside constitute a long. The period used for CCI and crossover levels can be optimized.|
|Commodity Channel Index Divergence||Draws CCI indicator, then the Divergence indicator pivot point is used to isolate.|
|Commodity Channel Index Fibonnaci Peaks||Plot 8, 13, and 21- Period oscillators on top of one another. Confirms the existence of peaks (or valleys) conforming to cycles in all three time frames.|
|Commodity Channel Index Peaks||Indicator that measures overbought vs. oversold levels by virtue of today’s price distance from the statistical mean price.|
|Chaikin Level Divergence||Draw the Chaikin Oscillator. The divergence pivot point method is used to identify divergence from a prior pivot point of the oscillator.|
|Chaikin Level Peaks||The Chaikin Oscillator rises when prices advance on higher volume, and goes negative on price declines on high volume. A reversal in the indicator indicates that the current trend in accumulation or distribution could be reversing.|
|Candle Pattern: Belt Hold||Pattern formed by a range which extends in the direction of the close. A Bearish Belt Hold exists when the High equals the Open and the Low is below the close. Similarly for the Bullish Belt Hold.|
|Candle Pattern: Counter Attack||Occurs when the market reverses direction violently to arrive at the same valuation as a prior period.|
|Candle Pattern: Doji Star||Occurs when the closing price equals the open.|
|Candle Pattern: Engulfing Line||Occurs when today’s range encloses or engulfs the prior day?s range, thereby indicating great market strength in the direction of today?s close.|
|Candle Pattern: Harami||Just the opposite of an engulfing line; yesterday’s body engulfs today’s, with opposite color for the two.|
|Candle Pattern: Hammer/Hanging Man||The Hammer pattern is formed by a short body at the top of a long tail. They indicate indecision in the direction of the trend. A solid hammer which occurs at the end of an uptrend is called a Hanging Man. This type of Hammer indicates the market?s propensity to sell off sharply.|
|Candle Pattern: Inverted Hammer.||Just the opposite of Hammers; a small body occurs at the bottom of a long tail.|
|Candle Pattern: Morning/Evening Star||A Morning Star is formed when a small body is located between two other bodies so that it appears below (or above) the other two. An Evening Star generates a sell signal when a small body is located above two surrounding candles.|
|Candle Pattern: Piercing Line/Dark Cloud||Occurs when today’s candle pierces the range of the prior day, in the opposite direction. The Bearish case is also called a Dark Cloud Cover.|
|+DI/-DI Crossover||Directional Movement comprises ADX, and has two components, +DI to measure movement to the upside, and -DI, for the opposite. When these two lines cross each other, the market is typically moving from one trend direction to the other. The period for DMI is optimizable.|
|Kirshenbaum Band Crossover||Measures market volatility using standard error of linear regression lines of the close. The effect is that they measure the volatility around the current trend.|
|MACD Divergence||Looks for divergence between the MACD line and price. This divergence is measured using the pivot point algorithm.|
|MACD Crossover||The MACD is constructed by plotting the difference between a 12-period exponential moving average and a 26-period moving average. A third moving average (the trigger line) generates trading signals when the MACD line crosses the trigger , in the direction of MACD.|
|Money Flow RSI Breakout||This indicator basically measures the amount of money flowing in or out of a particular stock. When Money Flow moves through zero, it is a sign that a given security is being accumulated or distributed. A separate moving average is provided to smooth the swings. The period used for MFR and the moving average period are both optimizable.|
|Money Flow RSI Divergence||Divergence, applied to Money Flow RSI. The system trades when MFR diverges from price.|
|Momentum Peaks||Momentum measures the amount a security’s price has changed over the past p periods. This system uses the peak signal method.|
|Two Moving Average Crossovers||The faster or shorter-term moving average will rise above a longer-term one, thus giving rise to a system that is in the market on the side of the faster average.|
|Price Rate of Change Crossover||Expresses the relative price movement as a percentage.|
|ROC +6/-6 Crossover||A classic +6%/-6% crossover system, which trades when the oscillator moves through +6% to the downside (short) and -6% to the upside (long). The period for ROC and the percentage level can both be optimized.|
|RSI +70/+30 Crossover||The Relative Strength oscillator (RSI), as defined by Welles Wilder, using a classic crossover interpretation. The system trades when RSI crosses through +30 to the upside (long) and +70 to the downside (short). The levels and periods for the RSI calculation can be optimized.|
|Relative Strength Index Divergence||Divergence trading signals occur when an indicator is sloping away, or diverging from the price trend.|
|Relative Strength Index Peaks||Based on the notion of comparing up days with down days, according to the theory that overbought levels follow a disproportionate number of periods in which the market advanced, whereas oversold levels generally occur after the market has declined for a significant number of periods.|
|STO +80/+20 Crossover||This is the classic Stochastics system which was included in our original systems for MetaStock. The system trades when Stochastics crosses +80 to the downside (short) and +20 to the upside (long). All parameters, including levels, %K and %D periods can be optimized.|
|Stochastic Divergence||The stochastics plot is drawn, and then divergence is measured using the indicator pivot point algorithm.|
|STO Classic %D||Moving Average Ts when the %D line crosses the %K line above given level (short) or below a given level long). Another classic interpretation of stochastics.|
|Stochastic Peaks||Stochastics measures the relative position of today?s close to the range of price action over the past p periods, and are based on the observation that price will typically extend to the end of a range before reversing.|
|TRIX Divergence||Divergence on the TRIX (Triple Exponential Moving Average) plot using the pivot point algorithm.|
|TRIX Momentum Fibonnaci Peaks||The 8-period, 13-period, 21-period TRIX momentum oscillators are used to arrive at the composite indicator.|
|TRIX Momentum Peaks||Yesterday?s value of TRIX is subtracted from today?s value to obtain a momentum curve which gives early signals.|
|Volume Accumulation Percent Breakout||Measures relative change in accumulation and distribution to detect places where the market is changing its perception about a security by taking a more active role in buying and selling it, relative to the immediate preceding time period.|
|Volume Accumulation Percent Band Crossover||A move above the threshold occurs at the same w/ time as price crosses a trading band.|
|Volume Accumulation Percent Divergence||The volume accumulation percent plot is drawn, and then divergence is measured using the indicator pivot point algorithm.|
|Volume Climax||System that attempts to identify situations in which prices reverse in the opposite direction as volume declines.|
|WIL %R -20/-80||William?s %R oscillator, with classic crossover Crossover. The system trades (long) when William?s %R crosses -80 to the upside, and short when the oscillator crosses -20 to the downside. The values for period and crossover levels are both optimizable in this system.|
|Williams %R Divergence||Williams %R ( an inverted, nonsmoothed Stochastic oscillator) plot is drawn and then divergence is measured using the pivot point algorithm.|
|Williams %R Peaks||Turning points of the Williams %R are determined.|
The bubble has burst on the equity market buy and hold dream as your retirement solution. You have to do more than simply trust someone else while only glancing at your pension statement once a quarter. It’s your money. Watch over it. Don’t pretend it’s just retirement and that it always goes back up — that is not true. It will go back up and you will make money only if you have a plan of attack.
View the Japanese Nikkei 225 stock index chart. It reached nearly 40,000 in the early 1990s. Now it hovers around 10,000 12 years later. Do you think the Japanese still actually believe in buy and hold?
Q. Can trend following be traded in a retirement account (IRA, SRA, Keogh, 401K)?
A. Yes. Absolutely.
Q. For stocks, futures, commodities and or currencies? Going long and short? Bull or bear market?
A. Yes. Absolutely.
What can happen when you trust someone else:
1. Think about how you got here and learn how others actually win. 2. Decide where you want to go, and what you’re willing to do to get there. 3. Now, get to it with a plan.
Ponder the words of Jonathan Hoenig:
Trading isn’t about making hundreds of transactions or jumping on a hot stock. It’s about being open-minded enough to realize that we don’t know the future — and flexible enough to admit that at some point we might want to trade one position for another. I am a trader because my interest isn’t in owning stocks per se, but in making money. And while I do trade in stocks (among other investments), I don’t have blind faith that stocks will necessarily be higher by the time I’m ready to retire. If history has demonstrated anything, it’s that we can’t simply put our portfolios on autopilot and expect things to turn out for the best. You can’t be a trader when you’re right and an investor when you’re wrong. That’s how you lose.
Allan Sloan on retirement today:
Once upon a time, back when the bull market was roaring, it was easy to fantasize about rising stock prices giving you financial independence in your forties. Your toughest decision in retirement would then be whether to take a cruise or stay home and wax your Ferrari. Everyone with money in the market — and their ranks grew by millions a year — seemed to be getting rich through options or stock-laden retirement accounts…It was sure nice while the fantasy lasted. But it didn’t last, of course. The stock market, down 25 percent from its high, has posted two years of losses and is barely breaking even this year. The future of Social Security isn’t looking too great, either…So now, with your portfolio trashed and Social Security looking insecure, you may be having nightmares about spending your retirement haunting the mac-and-cheese early-bird specials, or about not being able to retire until six years after you’ve died. With the bull market gone, will the impending retirement of the post-World War II generation be the Boomer Bust?…If you work hard, save and adopt more realistic expectations, you can still retire rather than die in the harness. It’s just not going to be as easy as it was in the ’80s and ’90s. Remember that for 56 years before the bull market, millions of people managed to retire without having to move into cardboard boxes or their kids’ basements. Earning maybe 9 percent on stocks isn’t as good as the 20 percent that you might have grown used to. But it’s not bad.
We generally like Alan Sloan. Pragmatic guy. Seems to be a straight shooter. But, saying 9% compounded is not bad compared to 20% compounded, ignores the pure math.
Imagine the last 25 years and 2 investments of $1000 each. Investment one generated 9% for 25 years and investment two generated 20% for 25 years. Does it seem like a big difference?
- $1000 compounded at 09% for 25 years = $8600.
- $1000 compounded at 20% for 25 years = $95,000.
It is a huge difference!
Trend following shoots for 25 to 100%+ returns. Compound those potential returns and you have a chance to make some serious cash.
Barber Shop Quotes
“The conviction that the party is far from over is part of the reason…technology stocks soar ever higher. I don’t think anything could shake my confidence in this market, Mr. Allen says. Mr. O’Keefe adds: Even if we do go down 30%, we’ll just come right back.”
“There was that bad stretch a little while back,” he says. Guys called me up and said, What do I do? I told them, Buy more.”
“Tech-Stock Chit-Chat Enriches Many Cape Cod Locals”
The Wall Street Journal
March 13, 2000
“All they ever say is, Buy, buy, buy, all the way down from $100 a share to bankruptcy, the burly 63-year-old barber said…Now, they give a stock tip and I stay as far away from it as I can. Nobody trusts anyone any more.”
“Indeed, while mostly avoiding investments in more stocks, Mr. Flynn has been driving to a casino in nearby Connecticut every Monday to play blackjack and poker. I do better there than I do in the market, notes Mr. Flynn.”
“At Cape Cod Barber Shop, Slumping Stocks Clip Buzz”
The Wall Street Journal
July 8, 2002
Trading like Warren Buffett is great if you bought 40 years ago. Today you can’t rely on markets going up forever. Doesn’t it make sense to have a plan based on more than human judgement?
Trend followers don’t look at balance sheets, care about P/E ratios or worry about earnings. It’s all about the price and following the trend. That’s it. Fundamental traders who learn trend following will be better traders by understanding their own weaknesses.
Questions? Send email.
Floor traders can benefit from better understanding the methods employed by trend followers. Instead of relying on floor information and news, use the knowledge of trend following. Seeing trend following broken down makes all floor traders better prepared to profit from the actions of others. No more guessing where block orders are coming from or what direction they are going.
Farmers know the benefits of trading and hedging. But do they know the techniques that speculators employ to take their hedging dollars away from them? Trading is a zero sum game after all. TurtleTrader profiles great success stories like those of John W. …
Farmers know the benefits of trading and hedging. But do they know the techniques that speculators employ to take their hedging dollars away from them? Trading is a zero sum game after all.
TurtleTrader profiles great success stories like those of John W. Henry, owner of the Florida Marlins, legendary trader and a former farmer who opened his first account with $16,000 USD.
Henry is a long term trend follower. You will find the many correlation studies on the site show that Henry often makes and loses money at the same time as other trend followers. What does that say about their techniques? Very similar …
More on Henry.
Day trading is a very difficult strategy to make profitable. For most people it is essentially gambling. There are stories about the easy road to riches via day trading, but most are BS and typically end in financial ruin.
Can shorter term trading (day trading) work? Yes, but you better have the technology and trading expertise of a Monroe Trout. It takes much more technology and physical work to trade short-term techniques for a profit. It’s nothing like trend following. Nothing.
More on day trading hype #1.
More on day trading hype #2.
More on day trading hype #3.
Day Trading Futility
“Day Traders Take a Fast and Costly Route”, by Stanley W. Angrist
The Wall Street Journal
Every day is not a payday for most traders. Day traders are investors who open and close market positions within the same trading day. They hope their market insights, trading skills and speed of action will allow them to take some profits home each day. In reality, most day traders find that what looks easy on paper is hard to do in the market. Consider Jeffrey Needleman, a wholesale stamp dealer from Ann Arbor, Mich., who has been investing for 25 years, most of that as a day trader. He says that during the past 10 years he has run a $10,000 account into more than $100,000 in a few months 7 or 8 times but always manages to collapse it back to below its starting value in a few weeks. When you have 30 or 40 winning trades in a row you begin to believe you are onto something and so you start to overtrade and the market takes it all back, explains Mr. Needleman.
Most market professionals shun day trading, arguing that the costs of getting in and out of trades that usually produce only small profits and some inevitable losses will eventually deplete the equity in the accounts of all but the most skilled. But traders like Mr. Needleman don’t much care about expert opinion. He says he is neither a high liver nor consumed with a desire to have great wealth. What he likes, he says, are the big video game aspects of day trading. When brokerage firms ask what his goals are, his stock response is that I just want to have a wonderful time losing my equity. Other investors explain their affection for day trading in more expected ways. Kent Taylor, an Austin, Texas, investor who traded stock options before he began day trading futures full time in August 1992, says, I like to go to sleep at night and not worry about the market ‘gaping open’ against me. An opening gap is when market prices begin the day at a substantially higher or lower level than the previous day’s close.
Two things determine whether an investment is attractive to day traders. One is liquidity, or the volume of trading. The other is volatility, or the size of price moves. When the volume of trading is heavy the bid-ask spread for an investment is small, meaning day traders can profit on small price moves. The second requirement, volatility, means the investments must move enough during the day so that the traders will be able to overcome their costs and still be left with a profit. More than any other individual investors, day traders see their activity as a business. They believe that if they do their homework they will spot a significant move in the market before the rest of the trading world, capture a part of that move, and then exit with a profit. Anthony Eck, 39 years old, who trades out of his home in Austin, says that getting out quickly is an absolute necessity. So is a strict control system that limits both profits and losses. Trading mostly currency contracts, he will risk no more than $125 a contract. His average loss generally is no more than $50 and his average profit is a minuscule $62 per contract. While many traders would scoff at such numbers, Mr. Eck says that 71% of his trades have been profitable since he started trading about a year ago, making his trading profitable overall.
om Meadows, who has been day trading full time only since March, hopes he can make a living doing it, but so far his losses exceed his profits. Mr. Meadows, 50, a former software manager in Austin, says day trading is appealing to him because I like the idea of having my finger on the pulse of the American economy. Day trading requires constant attention. In addition to the frequently changing bid-ask spread, day traders also must cope with the time differential required for brokers to fill their orders. It’s a business where seconds count. Mr. Taylor, who trades mostly currency and the S&P stock futures, says he places his orders by phoning clerks stationed in booths along the periphery of the trading pit. He says the clerks can execute an order and report the price to him in less than a minute from the time he picks up the phone to place his order.
Although all day traders claim they kiss the losers good-bye fast, the general lack of success for most suggest they might be a bit slow on the exit. David Morse, trades from his home in Atlantic City, N.J., says he has been far more successful at the blackjack tables, which he visits after the markets close, than he has been in day trading. After 10 years of trading, I would give a pint of blood to be able to trade successfully, he laments.
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