Trend Following

Don't think about what the market's going to do; you have absolutely no control over that. Think about what you're going to do if it gets there - William Eckhardt


I searched "trend following" on google the other day and one of the responses was from Wikipedia:


In finance, trend following is an investment strategy that tries to take advantage of long-term moves that seem to play out in various markets. ... Traders who subscribe to a trend following strategy do not aim to forecast or predict markets or price levels; they simply jump on the trend and ride it.


The last sentence is one of the main factors which drew me towards trend following, and mechanical systems trading in general. Prediction does not play a role. You do not have to know what is going to happen next in order to be profitable.


Prediction, or forecasting, is something that is subjective, or opinion-based. With trend following (or system development of any style) everything we do, every rule, every parameter, its not subjective or opinion based, but rather, its evidence based. If it can't be tested then you don't trade it.


The other day, just for practice, I ran a scan of the ASX using my entry criteria and I got about 20 signals! Due to the limited capital available, I can only afford maybe 12 or 13, so I decided to (hypothetically) buy the lower priced shares. Then i thought, hold on, i didn't factor a price filter into my entry filter during backtesting, so I have no reason to believe that lower priced shares will provide better gains. Hold on, let me rephrase that, while I actually do have reason to believe that lower priced shares provide better gains (through Nick Radge's "Bang for Buck" study), the benefit of employing this strategy for my system has not yet been quantified.

Regardless of which method I choose to pick the stocks to buy (out of those that gave entry signals), it shouldn't matter too much, and discretion can be applied here. This is the reason we do monte carlo analysis. Whether I study the charts or flip a coin, no matter how I choose, allowing for a margin of error (10-20%), the results should still fall within the minimum and maximum amounts returned from the monte carlo analysis of the out-of-sample data. Backtesting is not an exact science, but its the best tool we have. And applied correctly, it can give us a good idea of how a system is expected to perform.

Michael Covel has done some great work on trend following. In addition to his first excellent book, he has a second book coming out soon titled: "The complete turtle trader". Michael Covel also did a presentation about the turtles and trend following at a conference in Tokyo earlier this year. The videos can be found on YouTube. Well worth a watch.