The Hunt brothers tried to corner the silver market in the late 1970s. Silver went from $11 to $50 during the Hunt brothers' manipulation. Fortunes were made and lost. Beginning in the early 1970s, the Hunt brothers started accumulating large amounts of silver. By mid-1979, the Hunt brothers virtually cornered the total global silver market. The brothers made a tremendous profit estimated at between $2 billion to $4 billion due to their enormous silver bet. In today's terms, this amount I would assume would be in the tens of billions or possibly more. Silver prices ultimately returned from the stratosphere and collapsed to below $11 eventually. The largest single-day drop in the price of silver occurred on so-called Silver Thursday. The Hunt brothers ended up filing for bankruptcy in September 1988, largely due to lawsuits incurred as a result of their silver speculation. However, during this period trend followers who had a plan and the tenacity to follow their plan created fortunes for themselves and their grandchildren. Trends will go to extremes. You need to have the patience and fortitude to let them run without interfering.
As much as cutting losses is important to long-term success while trend following, the aspect of exits and when to exit may have more of an impact in your long-term success as exemplified in the preceding paragraphs.
You have to have the drive, dedication, discipline, patience, and passion to give yourself the potential for success in trading.
CHAPTER 2
Getting the Most Out of This Method
Do not delude yourself. You will not instantly become successful the minute you finish reading this manual. You run the possibility of making your money over a long series of trades. You need to have realistic expectations of yourself and my trend following methodology. Once you internalize the fact that you will make your money over a series of trades, it makes it a lot easier to handle the inherent losses when trading. You will come to grips with the fact that any trade in any month or any year does not really matter as long as you have kept your losses small.
Too often, people start trading with dreams of becoming rich overnight. I am of the belief of trying to compound your money over time. I do not like taking big risks when I trade. It's much safer to maintain a trading strategy that will allow your account to grow at a slower pace over time, which can ultimately be used for retirement or a child's education.
Compounding your way to wealth is not a get rich quick endeavor.
There will be no surprises when you trend follow as I outline in the book. You will have losses. You will have long periods when you might not make money, but if you stick with the strategy and stay in the marathon, you stand the potential to compound money over time.
My goal is to give you the realistic picture that I have personally encountered over the last 18 years of my trend following career. Trend following is not retirement in a box! You will have to do the work. You will have to work on yourself. You will have to build your discipline and patience muscles. There will be times when it will be very hard. In order to succeed over time you need to believe in the concepts. You'll learn key concepts that you can apply to your trading right away.
I am giving you my exact plan. There is nothing held back.
■ There Are No Secrets!
My plan is not perfect but it is robust and can be traded on any time frame and any market. Without a well-thought-out plan, trend following is very risky. However, with the right risk measures and the knowledge to use these in an efficient and effective manner, you put the odds of success on your side. Your trading plan requires a great deal of work. You need to develop the plan to match your personality, and it is even harder to follow the plan. You will have to follow through on difficult decisions and choices. Your plan must cover all the key elements of trading with risk, money management, and having the proper discipline and patience.
Developing a trading plan with all the time, energy, and effort devoted toward your future success still does not guarantee you your trading success. The markets need to move. With this movement the best you can try to do is not lose too much money. The market has a way of throwing you curveballs and unexpected twists. You need your strategy or your plan to get you through all of the unexpected outcomes prevalent in the market. Too many traders only consider the context of a plan after they have lost money. The plan consists of all potential precarious events before they happen. The plan should answer all the potential outcomes.
An example of this, as you will learn further on, I trail my stops with a trailing average true range stop indicator version that I wrote about in Stocks & Commodities magazine in 1998. The question as part of my trading plan is, if I touch my average true range stop, do I exit or do I have to close below it? The trading plan must answer this because in the heat of trading you do not want to be surprised. There is no free lunch when we trade. There will be times that the stop is touched and reverses. Frustration can easily be had.
Conversely, if one were to wait for a close below the average true range stop, the loss can be greatly enhanced. The only solution is to accept the risk and accept the outcome as part of your plan. You must not change your plan or rules in midstream. You strive for consistency. This consistency lowers the pressure as well as gives you the ability to repeat the trade process over and over again. Trading patterns repeat themselves over and over again. There are always an endless stream of potential trades on all time frames and all markets. You just have to be available.
■ Do You Want to Be Right or Make Money?
I have this question posed to me all throughout my journey. I prefer to make money and compound it over long periods of time. The funny thing is that many traders and investors don't like trend following. It is not intuitive, too long term at times, or simply not exciting enough. I am not in need of excitement.
Clearly there is nothing perfect in life or trading. You will have losses but these losses, as long as they are kept small, will be manageable. You will have ups and downs in your trading account. You will go through drawdowns. Losses are as natural as breathing.
Many cannot take losses. That is why they flocked to Madoff. They did not want to take small losses only to take total losses.
You decide; nothing is perfect! There is no free lunch.
In my opinion there is no other strategy out there that offers liquidity, transparency, and profit potential as much as trend following. Trend following strategies work on all markets, forex, stocks, and commodities. Trend following works on all time frames. If you want to day trade, the same rules apply as they do to trading daily charts. Trend following is not something new; it goes back decades!
Even with the success of trend following there are periods when profits are elusive. Many people consider trend following dead during these periods. In all honesty, my wife has asked me over and over again during my drawdowns if maybe trend following is over.
People, including my wife, ignore the tremendous track record that trend followers have built over the decades. They argue it is outdated; it has too many participants; or it simply just does not work anymore. Again and again they are proven wrong. At the darkest point comes the light.
Actually these are the best times to invest in trend following.
Trend following entails having a defined plan and strategy to put money into trades to achieve one and only one goal: profit.
Trend followers do not care what they own or what they sell or buy as long as they end up with more money than they started with. Trend followers will go short as often as they will go long, thus giving them the potential to make money in both up and down markets.
The fears associated with a potential market crash do not exist; the greed associated with a runaway bull market does not exist.
Trend followers do not worry about what the markets are going to do tomorrow. They have an exact plan with all contingencies thought out ahead of time. Trend followers are like surfers and look to ride the waves.
Trend followers have an exact plan. This plan is based on an objective and automated set of rules.
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Trend followers follow their plan without second guessing it. They believe in it! A trading plan makes life easier by eliminating emotions from the trading decisions. A trading plan forces discipline. If you do not follow the trading plan, you will not succeed. Do not even start if you cannot follow the plan.
■ Basic Tenets of Trend Following
The single biggest mistake traders make is thinking that investing and trading is easy.
They allow themselves to fall for advertisements promising, “You can get rich by trading” or “Earn all the income you've ever dreamed of” or “Leave your day job forever and live off your day-trading profits.” Trend following is not retirement in a box.
You Have to Work
The actual tenets of successful trend following are basically simple and intuitive in nature. However, in practicality trend following is very difficult due to our greed and fears.
In order to succeed over time with trend following you will need to internalize these tenets and make them part of your trading.
It is imperative for your long-term success to always cut losses short and take low-risk trades. You will realize when you start trend following, if you haven't already, that many trades simply do not work. Taking low-risk bets and keeping losses manageable are the cornerstone of successful trend following.
Don't trade to get rich quick. At best it takes a long time to compound money and there are no guarantees for the future. The only certainty is uncertainty!
Have realistic expectations. Losses are part of our business. There will be many. A trading system that doesn't have losses is “too good to be true.” The only truth about that trading system is that it will not make money in the real world.
Start Small
Remember to start small—walk before you run. When you are trend following successfully you trade only in the direction of the trend. There is no second-guessing or debating. You do not let your opinions get in the way. You have an exact plan to follow trades that are working as well as an exact plan to exit quickly trades that are not working.
I use only a few rules and they are very easy to understand. Do not confuse easy-to-
understand with easy-to-do. The more rules you have, the more likely that you've “curve-fitted” your trading strategy to past data, and such an overoptimized system is very unlikely to produce profits in real markets.
At the same time, it takes time to develop a successful strategy. This is why you should start small. Test potential rules before deciding to include them in your trading. It's important that your rules are easy to understand and execute. This ensures that your strategy is robust, adaptable, and easy to manage.
Compound Your Money over Time
Patience is also important when it comes to finding trading success. Every trader—no matter how experienced—has losing trades. I recommend keeping a long-term view. This can help you keep your emotions in check so you can quickly recover from losses, behave rationally, and follow your trading plan instead of getting distracted.
■ Compounding Your Way to Wealth
Repeatedly I have stressed that trend following is not easy nor the only way to compound your way to wealth.
There is a drawdown out there that can make one stop trend following.
As they have not followed their plan, even had a plan, or took on too much risk.
Regardless of the strictest risk and money management filters, there will be numerous losses. In order to compound money we must try to keep them small and manageable, otherwise we will not be compounding money. You will experience gaps that go against you as well days that are limit up or down. You cannot avoid or control these.
There will always be drawdowns and extended periods of elusive profits. In all honesty, trend following is the easiest yet the hardest thing to do. You will have deep and extended drawdowns that seem never to end. However, eventually there is light at the end of the tunnel. Out of nowhere trends appear, and accounts regain their lost values and hit new equity peaks.
Everyone has his or her belief system of how to try to compound money or simply invest. There are those who do real estate, invest in hedge funds, as well those that invest in their own personal business. As I stated, trend following is not the only solution to compound money over time, but it is the strategy I adhere to and I have personally been able to compound money over time.
There are no guarantees, however, that trend following will be right for you. Trend following is liquid and transparent where other strategies are not.
As much as nothing is for sure except uncertainty, I am confident that trend following will continue to work over time regardless of bull markets, bear markets, inflation, and deflation.
We all have heard of the Rule of 72 and the magic of compounding at some point in our education. However, for me, compounding money was elusive for a period of time. The reality is that for most traders it is also elusive. It took me many years until I was able to take money out of the markets.
Compounding Money Is the Key to Building Our Net Worth
Albert Einstein called compound interest “the greatest mathematical discovery of all time.”
Richard Russell, known from his work, The Dow Letters, has stated, “Compounding is the royal road to riches.” He also said, “Compounding is the safe road, the sure road, and fortunately anybody can do it.
This means possibly you.
Table 2.1 details what would happen to a $100,000 investment if one were able to compound that initial investment at an annual rate of between 10 percent and 20 percent.
TABLE 2.1 Compound Interest on $100,000 over Time
The chart tells us that a $100,000 investment compounding at 15 percent would grow in excess of $400,000 over a 10-year period. If that investment continued to compound at 15 percent per year, it would grow to over $800,000 five years later. Simple terms: in 10 years @ 15 percent you have 4 times your money and in 15 years you have 8 times.
In the manual I present real-time and real-money audited returns of some money managers. Now that you see Table 2.1 you can understand how these money managers were able to compound money to such extremes.
One of the key points that I will keep on reminding you is about keeping losses small. If losses grow to extremes, it negatively impacts our compounding or even may lead you to quit trend following.
Table 2.2 reflects the mathematics of recovering from losses.
TABLE 2.2 Recovering from Losses
This table actually shows us the importance of trying to mitigate losses. The bottom line is that it is very difficult to recover from large losses.
Figure 2.1 is a chart from American Century Investment that shows an equity curve of a portfolio that suffered a 50 percent decline. This chart indicates just how difficult it is to recover from large losses. A positive 8 percent compounded return for eight years will only bring your account back to even after initially suffering such a large loss. It is simply not easy to recover from large losses, and yet all markets will likely suffer 50 percent declines at some point. The power of compounding can work for you only if you do not suffer large losses.
FIGURE 2.1 Recovery after a 50 Percent Decline
All we can control is our risk. This is why it is so important to adhere to strict risk and money management rules. There always exists a draw down that can stop you from trend following. If you want to make trend following a lifetime strategy you must include strict risk & money management.
Keep It Simple and Stupid
Many people (including myself when I first began) think that the fancy Ivy schools or reams of research reports will bring trading profits. My proprietary robust ideas are more successful than complicated analysis. When I first began my journey of learning I sought out the holy grail. I thought there was some secret method, Fibonacci, Elliott wave, or Gann idea that would enable to me to make money. I personally have not been able to figure out or predict when a market will move. I reached the point where I realized that I could not nor can
anyone else accurately predict over time when a market will move.
I started to doubt that gurus really existed. Prechter was still a perma bear years after his great call of the stock market in 1987. Once I really internalized this, my anxiety level fell and I was okay not even thinking about or trying to predict or know why a market moved. I learned that anything can happen and will happen. I realized all information was in the price. I did not need to predict anything to be successful.
More so, I realized that no one knows anything more than me. I have invested with many commodity-trading advisors over the years. In the beginning I thought they were smarter or simply just better than my own trend following. I realized this is not the case. Some years I have had better returns in my trend following than some of the managers I invest with and some years I have worse. It does not matter, though, as I am looking to compound my money over long periods of time and want to try to smooth it out as best I can.
The Trend Following Bible Page 6