We can put stops in the market, but this is no guarantee that we cannot get caught in a limit move against us. Limit moves are set by the exchanges of a maximum permissible move allowed in a particular market. There are times when, as much as we want to exit, we cannot. The other reason I stress the word “try” is that there will be overnight gaps and moves, which as much as they can benefit us, are more apt to hurt us.
Stick to Your Plan
Another hard mistake for traders to overcome is that they do not follow their plan (if they have one) and exit a trade that is working due to the proverbial fear of losing money, greed of taking the money, or ego of being right or smart. Initially they might feel good and then Mr. Murphy shows up and the trade in which they exited prematurely ends up being a runaway trade. The trader has left a substantial amount of money on the table. The emotional roller-coaster starts with a great deal of disappointment and anxiety. I wish I had stayed in that trade. Why was I so stupid? The list can go and on. My solution is first, look out the front window. What has happened is over. All you can do is go forward and learn from it. What one needs to learn is the necessity of a plan and following it exactly.
A Look on the Bright Side
Going back to being slightly more positive, there is more to the idea than you want to make money. Do you want to be rich or wealthy? In my neighborhood I have both types of neighbors. I have wealthy ones and rich ones. What is the difference?
“Being rich” means that you have a lot of money. “Being wealthy” means that you actually have time to enjoy your money, time to do what you want to do when you want to do it.
I live five minutes from the beach and see many people early in the morning walking. I walk pretty much every morning, most of the time with my wife. What stuck out to both of us was that a very famous businessman would walk on the beach whenever it seemed he would have financial issues as reported in the newspapers. In 2008 we saw him for the first time. He walked with his head down in deep thought and concern. Again this year we would see him. What I gleaned from this was that he was rich but he was not wealthy. He owned one company after the other and was leveraged to the hilt. On the surface of it he seems unable to enjoy his money.
Contrarily, I am wealthy. I can do whatever and whenever I please. I take my trading with me. I have time for my family as well as charity work. I can only attribute this to trend following over the years. I compounded money over time. It has not been easy as I have gone through countless drawdowns, but I was patient and disciplined to keep in the marathon and not give up.
In retrospect I was fortunate that I struggled when I first started trading. This struggle planted the seeds in my psyche that trading is not easy and that I had to work. I am happy I did not encounter immediate short-term success that would have deluded me. I believe if I had had some amazing trades right from the get-go, I would have underestimated what is truly entailed for trading success. I might not have realized how quickly the market can take away my hard-earned profits. I probably would not have developed the risk profile in which I trade today.
You decide which you prefer!
■ Trading Pitfalls
With great excitement and probably nervousness you put on your first trade. Do not expect it to work (make money). It will be much better for you if your first couple of trades do not work. This will serve as a wakeup call on how hard trading really is. I would strongly suggest that you start small with money you can afford to lose, as you will make mistakes. Remember, 90 percent-plus of traders lose money and quit. I wish that you will become one of the 10 percenters who are consistently successful over time. I truly believe my book is unique and gives you all the tools.
On my blog, TrendFollowingMentor.com, there are many free educational pieces to help you and guide you. Reading my book and my material on my Web page, TrendFollowingmentor.com, should help you with one of the most important aspects of trading, patience and discipline.
Traders lack discipline for several emotional reasons. There is the fear element, greed element, and the ego element. These are all based on human nature. We all should trade for one paramount issue, to build an ever-increasing equity curve—greed. Who would ever want to put on a trade if they stood the distinct possibility of losing money? That is human nature. We want to be right; this is ego. Who really likes to lose money? This is where the fear comes into play. We are hard-wired for these human emotions. This is why discipline is hard to achieve. When we cut a loss, several interesting things happen. We are wrong and our ego could be damaged and our pocketbooks are damaged with a loss. Not too many people like being wrong and losing money at the same time. What a head trip! It is not human nature! Wouldn't it be so much easier just not taking the loss and hoping the trade will come back? Yes, it would be emotionally easier; however, this is one of the quickest ways to stop trading. Small losses morph into large losses.
Successful trend followers know that if they do not take small losses, these small losses can morph into big losses and cause both financial and emotional damage. This is why successful traders have built the discipline. They have let small losses turn into these big losses, and they do not want to have it happen again.
Lack of discipline can be evident in various other aspects of trading. Exiting a profitable trade contrary to your rules is due to lack of discipline and fear. Ego comes into the picture when people want to be considered right or smart on a trade. If they lock in the profit, all of a sudden they are right. These types of traders are lacking discipline. Taking their profit prematurely, they face the distinct possibility of missing the big trade of the year. They need that trade to offset all the numerous losses they will encounter.
Another example of lack of discipline are the traders who violate their trading plan (if they really have one), and once a trade goes against them, they average down and double down. They believe they are right and the market is wrong. It is almost funny to say this, but even professional traders have made this mistake of discipline and have blown up.
Conversely there are the type of traders who, when/if a trade starts to work, immediately add to that position. They want to make a killing. They want to get rich. This is ego. This enhanced leverage works both ways and is a double-edged sword. When a trade works and leverage is used, that is great. However, the more probable instance is when these trades do not work, leverage is used, and both financial and emotional pain is generated. I am not a psychologist; however, I have seen these types of instances in the market.
Discipline is really a hard attribute to build. It is almost like a muscle that needs to be built. You need to build a discipline muscle as well as a patience muscle. Discipline is one of the most difficult aspects of trading to overcome. You can have your exact trading plan and the “best” system, but it is for naught if you either do not take the next upcoming trade or fail to exit when you are supposed to.
You do not want to fail to pull the trigger on a trade. You do not want to miss a trade you should have taken. You do not want to let a small loss grow into a nightmare. If you miss one trade, you might miss an entire year of profits. The lack of discipline comes at the most critical time for a trader. Discipline is needed when you are in the thick of it or in a difficult situation. There are those that think simulated trades teach one discipline. I disagree wholeheartedly. There is a new feeling when you have real money and real risks on the line. All the supposed planning and preparation can go out the window. It is trite to tell a trader that he or she needs to control fear and greed. These are very strong emotions. When one is consistent (over time) the ability to overcome fear and greed are slightly easier to handle. Consistent means seeing a familiar situation that you have seen before and acted upon in exactly the same manner. You repeat the same action and are open and accepting of the consequences. You completely accept that the trade is 50/50, and if the trade does not work, you move on and take the next trade without any fear. Mechanical trading systems can assist in discipline, but it is still up to you t
o take the trade and be responsible for the outcome.
Interpreting charts is somewhat difficult. At times, if you do not have an exact plan with patterns that are recognizable, you might interpret the charts differently. Differently means you are not consistent. Consistency builds discipline and controls the inherent fear, greed, and ego.
The learning never stops. Do you really expect to make millions of dollars after only investing a few hours of time in your education? You wouldn't trust a lawyer or doctor whose only education was from a course or webinar!
If you're not willing to spend the time learning the techniques of trend following, not working on yourself as far as discipline and patience are concerned, then trend following might not be for you.
■ It's Your Choice
Trend following is all about making decisions, but before you actually begin trading, there are a few important things you'll need to consider. The basic decisions you should make deal with your chosen software platform, your trading time frame, and what markets you want to trade.
My trend following methodology is very simple and robust, and it will work on all platforms, time frames, and markets.
Your Charting Software and Computer System
You don't need the latest computer, and you don't need the most expensive or so-called fastest system. Basically, any computer or laptop that you've purchased in the past couple of years is fine. I trade with an ASUS laptop from a year ago. I have everything backed up on a desktop, an external hard drive, and a cloud. You do not need anything fancy, just solid, reliable, and durable. Forget about all the speed stuff that is touted.
Choosing the right charting software is a very personal decision. What another trader chooses may be different from what you choose, and vice versa. That's why it's important for you to carefully evaluate a list of features, considering both advantages and disadvantages before you make a decision on a data feed and charting package.
You can use Stocks & Commodities magazine's Reader's Choice as a starting point and try out various software platforms. I have been using Metastock, probably since around the time it came out in the marketplace, and I use Tradingblox, as well. There are pros and cons to both platforms.
Metastock Metastock was probably the first trading platform in the world that gave you the ability to create, test, and fully automate your own rule-based trading strategies on a daily basis. When you're ready for your first trade, Metastock can watch your trading rules and even carry out your trades 100 percent automatically. It is similar to autopilot, but I suggest you still try flying the plane yourself, at least initially.
Metastock is designed to help you discover some potential market opportunities and then perform your trades more professionally than you could ever do on your own. Metastock essentially monitors the markets for you tick by tick, in real time on the Internet, and seeks out all of the opportunities based on your trading plans.
The instant an opportunity arises based on your custom buy or sell rules, it's designed to automatically generate your entry and exit orders and send them to the marketplace within fractions of a second of the market move.
You can automate practically all of the trading strategies you could ever think of, including multiple orders, entries and exits, profit targets, protective stops, trailing stops, and more. It allows you to back-test, program custom indicators, and modify indicators to your needs. Then, with just a single click of your mouse, it will back-test your strategy on up to 20 years of authentic, intraday market data, giving you the simulated results. Metastock will provide you with information on all of the trades you would have positioned, your simulated net profit or losses, and much more, before you even risk one dollar from your real trading funds.
When you first set up Metastock, it may be a little overwhelming because of all the features and functions. However, for $1,395 (plus data charges) you can utilize Metastock's award-winning features and be off to a good start.
Tradingblox As I stated, there are reviews in Stocks & Commodities magazine to help you figure out what works best for you. On a portfolio level, I use Tradingblox. It lets me test out how my ideas test on a portfolio level. I would suggest walking before running. Walk forward means testing different periods of time in order to confirm that you have similar results both in percent profits and percent drawdowns. Try Metastock and if you are satisfied, purchase it for your trend following strategies. I teach with Metastock in my mentoring courses due to its robustness and simplicity.
You need to be comfortable with the platform and it is entirely your choice.
Time Frames for Trend Following
The term time frame refers to the length of time you plan to hold your trade. This is totally a personal decision based on your personality, risk profile, and account size. Day traders exit all of their positions at the close of the market. Position traders can hold trades for weeks or even years. You have to decide on your time frame. Do you want to trade short-term, long-term, or somewhere in between? This is a paramount decision regarding your trading career. Each time frame has its own prerequisite of both time and emotional energy.
Whatever time frame you chose, it must fit your personality as well as time constraints. Some traders simply do not have the patience to wait for an outcome of a trade. They are not emotionally built to hold a trade for month or longer. Traders like this should not even consider longer-term time frames. Conversely, if you have a full-time job, do not delude yourself that you can bop in and out of a position while you are juggling your real job. Can you imagine if you went to an attorney for a pressing issue? Suppose he comes in late for the meeting because he was watching his trading screen of five-minute S&P 500 bars. In the course of the meeting, he gets an alert on his BlackBerry to buy the S&P 500 futures and bolts out the door to place the order. I doubt that the lawyer will be successful nor that you would have confidence in the lawyer representing you. The lawyer thinks he can make easy money. He is lured into the money trap and cannon fodder for professional traders. I have heard stories like this, as ridiculous as they sound. You must trade your time constraints and there is no free lunch out there.
Day traders swear by their time frame and why it is optimal. Position traders will swear by their time frame and state their reasons. In both cases these traders are trading their personality. There is no best time frame. The best time frame is one that matches your time constraints and personality. There are traders who change time frames like some change their hairstyles. These traders are seeking the holy grail and have not accepted the inherent risks while trading. There is no way to avoid losses other than not trading. If I can put my two cents in, there is the inherent advantage to trade less to avoid slippage and commissions. This is just my opinion. I have found that more position traders over time are more successful than day traders. There is less emotional demand and stress on position trading than day trading.
Trade your personality as far as time frame; determine for yourself what time frame works the best for you.
You can sit in front of a computer and day trade or you can do as I do with daily bars. Personally, when I am trading daily bars from start to finish, I am usually finished in less than one hour. With the methods of trend following I will teach you, it is all the same. I download my data early in the morning and within less than one hour I am finished for the day. I know what I need to do exactly. I have exact entries, exits, and exact amounts of contracts or shares to buy. I am prepared and my orders are in the markets. It really does not matter what your exact entries are. A mechanical systematic trader might look for a breakout trade or a retracement trade (as I do). A fundamental trader might look for a favorable earnings report. Then there are those who rely on astrology or cycles. Don't laugh, I am serious, people even seek out astrology. The key is to have some type of realistic entry method that is replicative and identifiable so that once you see it on another trade you can repeat the action.
Regardless of the entries, they are one of the smallest pieces of th
e puzzle. Any trade is 50/50. The more important issues are the risk considerations such as how much to buy or sell and when to exit with either a profit or a loss.
Aspects of the Exit Exiting a trade is much more important than the entries. One of the hardest things for traders to do is actually take the appropriate exit as per their trading plan (if they have one). Trend followers need to ride major trends to make up for all of the small losses they encounter and maximize their profitability. Day traders, on the other hand, are happy to make a few ticks on the majority of their profitable trades. Both of these issues are personal issues that need to be addressed before trading commences. What I have found is that one of the hardest issues for a beginning trader is to have the patience to let the trade work. Once the trade starts working or trending fear or greed kicks in, there is the urge to lock in the short profit as opposed to letting it run. This will have devastating effects on a trader's account. Most trades do not work when one trend follows and cutting profits short is the direct route to failure in trading. One must have these rare big winners to offset the multitudes of trades that do not work and incur (hopefully) small losses. The reality of trend following is doing the uncomfortable. Trend following requires work. This work is developing your patience and discipline to let these trades run their course and not cut them short due to fear or greed. It is very easy to ring the cash register, and then this leads to another major issue of disappointment. Can you imagine if you had a trade that was working and out of fear or greed you took your quick profit only to watch it afterwards hitting multiyear highs or lows? This is the reality. Trends go to extremes. Do not feel bad. This is human nature. I once heard a lecture by Leo Melamed from CME who spoke about a silver trade he was in. Leo Melamed, the chairman of CME, exited a silver trade during the Hunt brothers' escapade thinking that it had gone far enough.
The Trend Following Bible Page 5