Wisdom From Richard Dennis Turtle Trader & Trend Follower | TrendFollowing
The market is never too high to long or too low to short. If you feel that you are always hesitating to pull the trigger because the market is overbought or oversold, dont be, because trend followers are doing what you are afraid of, longing into the highs and shorting into the lows. Check out this video here. If you are a trend follower, you will not pay much attention to support and resistance. And more often than not, you will be trading right into these levels when other traders are doing the opposite. And to be honest that is not wrong at all.
If you have a trading plan that tells you to short at resistance or long at support, with pre-defined stop loss then I would say its a good trade. But would you consider doing the opposite after being stopped out? If its a no, then I suppose you feel that price is over bought on wheat or oversold on crude oil. And this is something I want to get across to you, price is never too high to long or too low to short.
Dont predict how high or how low the markets can go, it doesnt care what you or I think. It simply goes where it wants to, determined by the mass psychology of the players in the market.
Accept that fact. And this is what trend following is all about. We follow the trend! I dont predict how high the markets can go or how low it can drop. If price is trading higher, I will look to long. Likewise if price is trading lower, I will look to short. Multi-year highs or lows, Im still coming for you. Try This! Every time you have a hunch that the market will reverse, jot it down on paper. After 30 attempts, look back at how accurate your prediction is.
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You may be surprised by your results. The recovery from risk of ruin is not linear, and could be impossible to recover from if it goes too deep. Yes, you read right. The question of how much to risk on each trade is dependent on your winning ratio, risk to reward, and your risk tolerance. If you want to calculate your risk of ruin, check out this risk of ruin calculator here. You can go broke taking profits if it is smaller than your losses. Yes, I know, that was how I reacted the first time I heard that statement.
Although trend followers have no profit targets, they do trail their stops accordingly and let the market hit their stop loss rather than pre-defining their profits in advance. Contradict that with what is taught out there, traders usually have a fixed profit target in mind.
Again, theres no right or wrong here; if it works for you, then great. If it doesnt, then you should do something about it, right? The difference between a profit target and a trailing stop is the willingness to ride your profits run. By having a profit target, you are, in fact, limiting your profits. Because you have a planned exit for your winning trades, isnt that trying to limit what the market wants to give you? By having a fixed profit target, its as good as saying, Ah, Im predicting the market will reverse at this point, thus I better get out at this exact level. But you just saw earlier that whats high can go higher and whats low can go lower.
And by having a fixed profit target, it goes against the earlier principle of trend following.
You may argue, but what if the market does reverse back to my entry and stop me out? Thats true and likewise, what if the market goes in your favor by more pips? Realistically speaking, you cannot base a trading system on just a handful of trades. You need to judge it based on at least trades to determine whether you have an edge in the markets.
Likewise, just because you get stopped out of your trades a few times while attempting to let it run, it doesnt mean its not a viable approach. Do it a times and let the numbers decide for itself. So what do you do? If you ask me, the best way is trade your exact trading system but this time around, let your profits run and exit it with a trailing stop loss, do it on a demo, of course. After trades, decide which gives you a better expectancy. The numbers dont lie. Risk to reward and winning percentage are inversely correlated.
The better your risk to reward, the poorer your winning percentage will be. Likewise the poorer your risk to reward, the better your winning percentage will be. Compared to other trading methodology, which focuses on a few markets or just one market, trend followers trade all markets.
How many of the 'Market Wizards' blew up?
Trend following doesnt focus on a single sector. It looks at everything across the board, currencies, agriculture, metals, bonds, energy, indices, orange juice, pork bellies, etc. Basically, anything thats liquid enough, trend followers will be involved with it. As you have probably heard, the market spends more time ranging than it is trending. Thus, by increasing your exposure to all markets around the world, youd greatly increase your odds of capturing a trend, right?
If you recall, most major currencies were ranging with extreme low volatility during the 1st half of Do You Know? Hedge funds that adopt a trend following approach trade as many as markets? This made life very difficult for a lot of Forex traders, especially those trading the higher time frames. Because trend followers trade all markets, there are usually other sectors in the markets trending while the Forex markets are ranging.
And this is one of the key reasons trend following has withstood the test of time; be it years ago or now, it is still a profitable method to trade the markets.
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Because trend followers do not marry themselves to a certain market, but trade all markets. And it is difficult to have all markets ranging or have low volatility occurring at the same time. Now I will explain to you the edge a trend follower has and why it is profitable over the long run, over the last years, in fact. By increasing the number of uncorrelated markets you trade, you are effectively diversifying risk in your portfolio.
Aside from the research studies I mentioned earlier, is there any logic to why trend following has an edge in the markets? You keep applying this approach to the different markets out there, looking for a small profit target with no stop loss. What do you think will happen over the long run? You may get lucky the first few times, but after a series of trades, you will agree you will eventually blow up your account, right?
Now what if I am on the opposite side of your trade instead? I may lose a few times consecutively but I know that all I need is one trade to make it all back. And this is the very same trade that caused you to blow up your account earlier. Can you see the edge of a trend follower now? However, if thats the case, then events like the crash of 87, the dot com bubble, financial crisis, etc. To put things into perspective, the financial crisis was a 25 sigma event.
What does that mean? It means the odds of it occurring is so infinitely small, it should have never happened at all.
To give you an analogy, a 25 sigma even is like winning the lottery 22 times in a row! What are the odds of that? So now that you can throw out the normal distribution curve that academics preach, then what should the curve really look like instead? In a more practical word, the tails are much fatter and this means that big events like the financial crisis, etc. And the thing about trend following is that it thrives during volatile periods like these.
So when you have fat tails events occurring more often than anticipated, it presents money making opportunities for trend followers.
You can read Trend Following with Managed Futures by Alex Greyserman, which explains how trend followers deliver crisis alpha. So now you know trend following has a statistical edge in the markets, its time to learn a simple trend following strategy that has an edge in the markets. But one thing I have learned through the years of trading is that you cannot simply copy someone elses trading strategy and use it exactly.
You will most likely fail as you do not have the conviction behind the strategy or it may not fit your personality. Instead what you should do is to tweak that trading strategy and mold it to your own style and personality. Now that you know the 5 principles behind trend following, I will share with you a trend following strategy that incorporates all 5 elements of it.
Guidelines Do not shift stop loss to break even. You either get stopped out on the initial stop loss or the trailing stop loss. Trade as many markets as possible with low correlations.