The Trend Following Bible

by Andrew Abraham

  FIGURE 9.7 Crude Oil Rally and Crash

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  Since we know (or I hope you will learn) that anything can happen, what makes you think you can predict it?

  Predicting is a complete waste of time. One does not need to know the future in order to make money. All we need to do is take low-risk bets and stumble into trends. The market will do whatever it wants; it is not about you or me. The market does not care.

  Successful trend followers know that they do not know what will happen.

  They think in terms of probabilities and possibilities. Once one thinks in terms of probabilities one becomes more confident, less stressed, and less fearful.

  We are programming our minds to be successful trend followers. In order to be a successful trend follower we need to trade without fear or overconfidence. We must see what the market is offering us, take action on this, and make ourselves available for opportunities.

  When one is in fear, opportunities are blocked. For example, your last trade did not work, so you do not take the next trade?

  If you do not take that trade, you had fear of losing money.

  To make matters worse and to beat yourself up, that next trade could have made up for all of the other small losses or been the big rare winner of the year.

  ■ Traders Lose Because of Fear

  Accept the fear!

  Accept that fact that most trades will not work!

  Big deal, you are taking low-risk bets that are between .5 percent and 1.5 percent of your whole account size. You are able to take many small losses. Small losses do not ruin your mental state or at least they shouldn't. Be extremely wary of system sellers who claim their system or methodology has a high win rate. You will experience losses in a row multiple times. This is why we attempt to keep losses small. However, you will see in Figure 9.8 that one trade we incurred -1.9 percent loss. This loss was much more than we target however this loss was probably due to a gap up/down or limit days. These type of losses can't be avoided.

  FIGURE 9.8 Losses Greater Than We Anticipate Due to Gaps or Limit Moves

  Stay focused and “just take the trade if it fits your trading plan.” You have a plan, you follow the plan, you take low-risk bets, you have realistic expectations, and you compound your way to wealth over time.

  ■ It Is All Perception

  Take the threat of fear or pain out of your market information.

  Successful trend followers don't feel anything painful nor do they experience fear about putting on a trade. They “Just put the trade on!”

  Successful trend followers have internalized that there is an endless stream of opportunities and that many of these trades will not work. I even say to myself, “ How much will this trade cost me to see if it will work”!

  Internalize and start truly believing in the following statements. If you need to write them down and put them next to your computer.

  There is abundance in the markets.

  There are always oppurtunities

  Successful trend followers are objective in their trading.

  They just flow with the markets without trying to control or predict anything.

  Successful trend followers will go long or short and never try to impose their opinions or belief systems on their trading.

  They are focused on opportunities and follow their plan flawlessly!

  They perceive opportunities!

  They know what an opportunity looks like.

  The markets are constantly offering us opportunities!

  We are surrounded by potential abundance and opportunities, not pain or fear.

  Fear is irrational and almost stupid when one is the “Just do it” mode.

  Successful trend followers know when they are in the “just do it” mode.

  ■ Just Take the Trade Mode

  Each trade is a probable event. Statistically it is independent from every other trade, and investors should simply follow their plan. They perceive the opportunities as a way to compound their way to wealth over time.

  There is no threat of pain or fear.

  The Key Is to Be Consistent

  Successful trend followers are consistent in their plan and execution. They do not have any magical indicators nor are they gurus. In simple terms, they have a plan and focus on executing the plan. In contradiction, the novices put on trades without any plan. Sometime they work and they make a lot of money. These trades empower them and at times lead them to trade recklessly. This reckless trading leads to large unexpected losses.

  This is why is trading is so hard to master.

  In order to be consistent one must first have a well-thought-out plan and even more so follow it meticulously.

  There is no fear, greed, boredom, or even having fun. Trend followers with a plan “Just Do It,” trend followers focus on execution.

  Successful trend followers trade in order to compound money over time. They are not looking for action or seeking to relieve boredom.

  They are consistent.

  They do not have to try to be consistent, they are consistent. It all comes naturally. It just flows. Being consistent is not something that you can try to be, you must be consistent. You take every trade that your methodology presents you. You do not second guess your methodology. You don't try to get anything from the market; rather, you make yourself available for the next opportunity. You take advantage of what the market is offering you at any particular time.

  You stay in the moment and be consistent.

  You have accepted the risks when you are consistent.

  There Is No Fear or Pain

  Basically fear will cause you to make more errors and cost you more money. One cannot avoid losing trades. They are as natural as breathing. You take responsibility for your actions when you are consistent. There are no limitations or expectations when you are consistent. You are just putting trades on and saying to yourself “Let's see what happens.” I promise you there will be numerous losing trades. As long as you keep them small, they mean nothing.

  One of the overriding issues that I gleaned from the Market Wizards book by Jack Schwager was not only the profits these unique traders made but the fact that all the successful traders stressed the need to cut losses and keep all losses small. Sadly, most traders do not get this message. Many traders are confused about using tight stops or wide stops or even no stops. There is no exact right answer except the exit stops need to be thought out ahead of time before one trades. Once one commences trading one needs to have the stops in place and needs to stick to one's exact plan and not move the stops.

  Stops are used to protect your trading capital. Stops are the basis of risk control. Risk control is what gives you the strength to stay in the marathon of trading. Taking small losses is a lot easier on the pocket and the emotions.

  Some traders are blinded by greed and only look at the profits. You will not have profits if you do not manage the risks. On one level I can understand. No one wants to hear bad news. However, cutting losses is not bad news, it is rather a necessity for success over time. It is hard to accept losses. No one likes to lose money especially when they follow their plan and they are rewarded with a loss. I personally have no problem taking losses as I feel if I do not exit, the situation can morph into a situation in which I lose more money and worse, affect my mental state. Trading is not about being right or having an ego. Trading is about not being too wrong and letting a loss morph into a big loss, which impacts the trading account and the psyche. This is what makes trading so hard; we put on trades and we hope or expect profits. Otherwise why would anyone risk his or her hard-earned money? The problem arises when a trader encounters a trade that is not working and takes it personally. This type of trader has a major issue accepting that the trade has not worked and they are “wrong.” I check my ego before I start my day. There is no wrong or right. The trades either work or they don't work. My day starts with the firm belief that anything c
an happen and I need to be humble. Otherwise I will probably be out of business. I know that the safest thing for me is to take a small loss and move on to the next trade, otherwise this small loss can have extreme consequences for both my trading account and my emotional state.

  There is no wrong, losing, missing out, second guessing, or any other mental baggage when you are consistent when following your trading plan. You do not look to avoid anything or any pain. You let the market do its own thing and unfold and let yourself be available for the opportunity flow. The market is going to do whatever it wants. The market does not care about you or me.

  Don't Try to Control It

  No one can control the market. No one knows where any market is really ever going for sure. You do not need to know where a market is headed in order to make money. Why even try to think about it?

  Accept the risk!

  Define the risk!

  Once you do this there is no struggle or pain. You are in the “just do it” mode. You will not perceive anything that the market can do as threatening. There is nothing to fear. It's all about taking responsibility for your trading.

  Sadly, most traders have an issue taking responsibility. It is easier to blame the broker, the data, the system, or the market rather than themselves. It is hard to put into practice taking responsibility. However, those who want to play the blame game will never be successful trend followers.

  In order to reach this elusive level of success you must take responsibility. Successful traders take responsibility for all of their actions. They trade without any fear or anxiety.

  When they are trading their exact plan, they are aware of not being reckless and every potential outcome has been thought out.

  They have restraint, patience, and discipline.

  I have seen countless traders who would spend hours planning their trades and instead of just putting them on and seeing what happens they freeze and don't put them on. They watch something on CNBC or a friend gives them a tip contrary to their plan and they do not execute their plan. It is like Murphy's Law, they do not take the trade, and these trades could have been the big winner.

  Trend followers need these big winners to succeed over time.

  It Is All About Attitude

  I have personally seen this occur repeatedly with traders.

  I have been investing with commodity trading advisors since 1994. I have seen commodity trading advisors and even my dentist colleague with simple, robust, and even mediocre trading techniques that have the correct tools as far as mindset outperform other more astute traders. Some of the better or astute traders might have better analysis or systematic trend following methodologies; however they lack the proper mindset. They hesitate, they pick and choose their trades, and they jump the gun or simply pass on trades they do not like. Some of these traders are simply brilliant; however, they do not make money. They operate out of fear while the less brilliant trader follows his or her plan and compounds money over time.

  Attitude separates success and failure.

  Ideally we would want both and in actuality you need both. With a robust methodology that trades all markets and all time frames the same with proper money management and proper mindset, you are on your way to compounding money. Sadly, most traders think they need to read every article in the Wall Street Journal or figure out what will happen in the world to make money.

  The truth is much further than that.

  Once you start believing in your trading methodology and following it exactly to the plan, you will realize that no one knows anything more than you, nor is there anything to predict. Really, no one knows where the dollar is going or where gold is going. If you can internalize that, anything is possible. Gold can go to $3,000 or $300 and you do not care.

  The Dow can go to 20,000 or 2,000. You do not care nor are you at the mercy of the markets.

  Think Like an Olympic Athlete!

  Get in the Nike “Just do it” mode!

  World-class athletes have the winning attitude. They envision themselves in the now moment. They envision that they have already won. They do not beat themselves up after making errors, they keep going. World-class athletes just do it, as Nike says. It is almost the same when we drive a car. We just do it. We learned how to learn, we wear a seat belt, we have our cars checked, and then we just drive.

  It is the same with trading. You can be confident, not overwhelmed with fear or greed, not afraid to miss out, you just flow with the markets.

  You have a positive and reasonable expectation of yourself and your trend following. More so, you accept whatever results you get as an indication of where you are and what the market gives you. No matter how brilliant you are, if there are no trends depending on your time frame, you will not make money. My simple analogy, I tell traders, is that if the fish are not out, you will not catch any fish no matter how good your fishing rod is.

  No Way to Avoid a Loss

  Losses are as natural as profits. When you try to avoid them you will put yourself in a position to lose even more. There is no holy grail or any guru. Losing is a natural outcome of trading. Trading patterns and trends repeat themselves but not every time. When they do not repeat, we have losses. Do not expect the market to fulfill your expectations. Be pleasantly surprised when a trade works because it does not have to. As I stated earlier, take responsibility for all outcomes. There is an endless stream of opportunities. You are responsible for your success and failure as a trend follower. No one else! If you do not follow your plan, you will be destined to failure. Perceive the endless flow of opportunities. Enter, exit trades without fear, criticism, or regret and let the plan work over time. Be consistent, patient, and disciplined. Once you enter this mode of attitude, you flow with the markets without anger, fear, betrayal, disappointment, or despair. I know this sounds very pink but it is doable. It took many years of trend following to get into this mode. That is why you purchased this book and hopefully you will use my services to help you become a better trader and compound money over time.

  Basically, you need to be relaxed when trading. You can't try to be relaxed; it just has to be not stressful. It just flows. Have a carefree state of mind. It is similar to driving. You have a carefree state of mind without worry or fear. You just drive.

  When you have numerous trades working you are the most susceptible to making mistakes, overtrading, putting on too big of a position, breaking your plan or rules. Basically, you might feel invincible. This defies common sense and will bring on disastrous results. Cockiness is the antithesis of successful trading. The markets are humbling.

  The reality is that only a small handful of trend followers are long-term successful. When I say small handful I would assume less than 10 percent.

  Besides my own trend following I have been investing with other commodity trading advisors since 1994. There are thousands of them to choose from. However, there are only a small number of CTAs that I have invested with and compounded money with. I chose them not just by their record, rather by how they think and approach risk.

  The irony is that countless professional traders do not approach risk in the appropriate way. Now if you take into account nonprofessional traders who do not address risks, the failure rate skyrockets. Many traders go through boom and bust cycles. Either they do not have rules or they ignore them. The boom and busters make money and then end up losing more. Their equity curves look like a roller-coaster ride.

  There is another group of traders that are the antithesis of the consistent compounding of successful trend followers. All of this has nothing to do with years of trading or methodologies. It all boils down to attitude, patience, discipline, and following a well-thought-out plan based on risk and money management. But these traders are full of fear and greed. Successful trend followers check those attributes at the door. I have heard repeatedly from brokers that their job is to keep their client traders from terminally damaging themselves. It is just a matter of time until they quit.

  ■ This W
ill Not Be You

  My goal is to help you compound money over time. I had a mentor who taught me how to think. My mentors taught me that there is no holy grail. My mentors taught me my money would be made over a long series of trades. My mentors taught me that the market does not care about me. I cannot get revenge on the market. My mentors taught me to take responsibility for my attitudes and my perspectives.

  This thought sticks out with a definition of a winning attitude:

  A positive expectation of my efforts all the while accepting my results are a reflection of where I am at in my learning and development as a trend follower. I have gotten to the point of just doing it! I have no fear or hesitation. I have developed a winning attitude. I am solely responsible for my winning attitude. I do not expect or demand anything from the markets. I do not expect that markets will do anything special for me or simply give me anything. The markets have a life of their own.

  If I can learn this, so can you!

  I did not go to Harvard!

  I did not work for a large hedge fund.

  Some of the most successful trend followers do not have large staffs or trading floors. Rather, they work out of their house or small offices. Bill Dunn, an extremely successful trend follower, started in the 1970s out of his house. At his pinnacle of success Bill Dunn was running in excess of $2 billion out of a small office. Another example is David Druz, who is currently managing $100 million and works only with a compliance worker who runs his office. Trend followers do not have large infrastructures in place.

  You will not need it either. After you have done the proper mental work, the actual trading does not take much time from your day. Within 30–60 minutes a day you can complete all of your trading.