Definition: Trend, n. – the general direction of the market. Prices move in trends
Trend following is the single most successful strategy ever employed by financial traders. Many successful trading professionals use trend following principles as the basis for their success. Trend following is an ideal method to trade financial spreads.
In 1983, Richard Dennis taught a group of 14 students the principles of a basic futures trading methodology. This group was nicknamed “The Turtles” and over the following 5 years, The Turtles earned $35 million dollars. Today, this group of Turtle traders manage a reported 2 billion dollars for investors and institutions all over the world.
The Turtle methodology was to use a simple breakout system coupled with strict money management guidelines. It was designed to use for futures markets and has met with remarkable success. Today, the Turtle lessons form the basis for most long term trend following traders.
I have used the Turtle principles as the basis for the Spread Trading Secrets system but with some unique features that I have developed over my trading career. They are ideally suited to spread trading.
Please be advised that no completely safe or risk-less trading system has ever been created and no one can guarantee profits or freedom from loss. A key advantage of financial spread trading is the opportunity to limit the extent of any loss to a specific level – guaranteed. This type of service will be explained later in the workbook but is unavailable in any futures or stock market.
The Spread Trading Secrets (STS) system is suggested as a technique you can use to attempt to manage risk in the pursuit of making above average returns on your investment capital.
As a Spread Trading Secrets trend follower, your challenge will be to apply some simple rules with understanding, patience, and discipline. The markets may confuse and frustrate you at times, and if you read all of the financial information available, you may get information overload. But even though the markets may appear complicated, making money from trading is simple.
Trend following makes the markets simple and easy to understand. Don’t reject a solution because it seems too simple. But don’t confuse simple with easy or risk free.
Everyone knows the formula for weight loss is simple – eat less and exercise more, yet most people find it difficult to lose weight. .
It is the application of the simple solution that is difficult. It takes discipline to do the right thing whether you feel like it or not. This is the key to successful trading.
First, let’s look at what you will be required to go through as a trend follower. We call it ‘The Trend Followers Patterns of Pain’
The above chart shows three re-occurring “Patterns of Pain” for the trend follower. There are three possible outcomes of all trend trades.
- a loss (Pattern 1),
- a breakeven (Pattern 2), and
- a profit (Pattern 3).
Every trade the trend follower makes will result in one of these outcomes or patterns, and with each of these patterns, there will be the potential for loss.
For illustration purposes, in the chart above the smoothed upper line indicates prices are in an UP trend. This is the signal to be long the market.
The middle line indicates a SIDE trend. This is the clearest signal to be out of the market.
In other words, the trend trader buys when the price closes above the upper line and liquidates when the price closes on the middle line. The specific entry tools will be discussed later in this workbook.
Pattern 1 is a losing trade virtually from the day the trade is entered. The best the trend trader can do in this case is to attempt to limit the loss by liquidating when the trend turns to SIDE.
Taking a loss like this is an unavoidable reality of trend trading. Once a trend has been signaled, it can change at any time – even immediately. It may be painful to take this quick loss and be proven wrong. It is worth remembering that every large loss began as a small loss. It is always a better alternative to limit a loss in accordance with your trading plan than to do nothing and risk an even greater loss.
By holding a losing trade, you may also lose the opportunity to catch the next new profitable trend, compounding the mistake.
Pattern 2 is a breakeven trade that was a profit at one point. You may feel like you made a mistake, giving back your potential profit by holding your position, trying to let your profits run. By sticking to the trend trading strategy, you suffer the loss of the unrealised profit you had at one time in the position.
Pattern 3 is a profitable trade. Success at last!
You made money, but look how much more you could have made if you could have gotten out at the bottom. This is only obvious with hindsight. If you try to outsmart the markets by getting out on a presumed high or low, you will miss the really big trend when it comes.
And you need the really big ones to make the overall long-term trend trading strategy profitable because more than half will be losing trades.
It’s an “ugly” way to trade, but it works.
Experience demonstrates that using closer money stops or closer intra-day stops does not necessarily reduce risk or improve performance. As markets become more volatile, the corrective swings within the trend become larger.
STOP LOSS: An order placed to close an existing trade in the event that the trade moves against you. It helps in preventing small trading losses become bigger trading losses.
To let profits run, the protective stop needs to be outside of the corrective range.
To let profits run in long-term trends, the system must maintain its position through the corrections in those trends. Of course, at some point one of the corrections will go further than a normal correction and signal a trend change. And the system will give back some profits.
I know of no better way to catch major trends.
Most unsuccessful traders waste their time and money, and sometimes their entire careers, looking for “better,” less painful ways to trade. They embark on a futile and never ending “Quest for the Holy Grail,” the search for the perfect money making system that produces a profit on every trade.
Don’t be tempted to join the “Quest.” Don’t get frustrated and think, “There has to be a better way to trade than this.”
The Holy Grail of trading does not exist. If it did there would be no markets. The trader with the perfect system would soon have all of the money, and the markets would be closed.
The element of randomness in price movement ensures that this sort of perfectly patterned world of trading will never exist. This is the basic nature of our competitive, free market system. All trading methods have their own characteristic drawbacks and “Patterns of Pain.”
Successful traders accept their trading system’s imperfections and continue to make money in these “ugly” markets with their simple trend following systems.
They have learned to use the simple rules for successful trading.
Successful traders are disciplined in their trading.
They do the right thing whether they feel like it or not and accept losses as an unavoidable part of their trading. They remove ego and emotions from their trading by following their system. They don’t associate losses with being wrong or losing.
Successful traders understand that taking losses is a necessary part of trading.
They also have confidence in the long-term success of their systematic approach, the patience to give it time to work, and the discipline to apply the rules of successful trading.