The Trend Following Bible

by Andrew Abraham

  I stayed in this trade and as per my system, I had an exit in the beginning of December 2011 as it hit the trailing average true range stop, or so it seemed to me. However, it did not by a tick or so. I exited the position and went on my happy way with finally a nice trade that had worked after a year of countless small losses. However, I realized a couple days later when my system showed me I was still short after realizing I had a data issue. The price of natural gas had fallen sharply and I did not think it was prudent to chase the trade. However, maybe introspectively my thought of prudence was fear of losing money. I had a good trade and locked in some nice profit. However, I just got a signal and the price was rather far away from where I exited. I thought to err on the side of prudence. Natural gas went from a good trade to a great trade. I pondered if I had broken my golden rule of not letting big profits get away. Regardless of pondering, the trade did get away and I missed out on a great deal of money that would have changed somewhat my negative return in 2011 on my Diversified $150,000 proprietary account. There was no point in beating myself up or looking out the back window. The question is what to learn from this. The answer is always to get in sync with the model. I might have had some fear of losing more than 1.25 percent. Maybe I did not accept the risk that was thrust upon me. The reality is that trading is always full of lessons. The biggest issue is not following your plan or having small losses morph into large losses. The year 2011 was a year of learning. After 18 years in the markets I thought I had made every mistake and had seen every mistake. But 2011 proved me wrong.

  Not that I am a glutton for punishment. October 2011 was full of some more pain for all trend followers. Ed Seykota has so aptly remarked that if you do not want to encounter whipsaw trades, do not trade. Most trend followers were in the Japanese yen trades in October 2011 and Ed Seykota's words resonated. I do not know any commodity trading advisors who quit due to these yen trades, but these were trades that we all will remember for several reasons. On October 12, 2011, I had a long breakout trade on the Japanese yen at 131.59. I held this trade for only two days. It almost immediately plunged and hit my stop. This is why stops are used. We do not know the future and need to try to keep our losses small. This trade of the Japanese yen resulted in a loss of –1.2 percent per unit of the portfolio or –$2,425 per unit. A week later my system signaled me to try the trade again. The good news I thought at the time was that due to position sizing, I could put on two contracts for the same risk. Wow, how lucky was I. Lucky was not the word. On October 31, that same lovely day that MF Global declared bankruptcy and $1.6 billion of client segregated funds supposedly “vaporized” the night before, the Japanese Central Bank decided to weaken the yen. The Japanese yen plummeted from 133.05 to 126.32. Yes, I was very lucky to have two contracts. At least they were mini contracts. This added to the pain of the MF Global collapse. It was like the icing on the cake. This trade cost me –1.2 percent or –$2,413.

  When I tell you trading is tough, this exemplifies it. I use the word marathon quite often. I also think of the Marines, the few, the proud, the brave. I scoff at all of those that try to make trading so easy. You can watch YouTube videos in which you can use a trading robot to get rich. Thousands of people flock to learn how to day trade. At this point it should be very clear what is really entailed with trading. It is hard work emotionally. Those that can do it benefit for the rest of their lives. They have financial freedom and are independent. Traders have a choice; they can fly the plane themselves. In this book I have really taught you everything in my opinion in how to trade successfully on your own. The other choice traders or investors have is to invest in traders who will manage their accounts and sit back on the plane. Do not be deluded—there will be turbulence. Trend following and trading is not retirement in a box!

  The MF Global debacle was an outright nightmare. I had wired out money on two programs that I was trading, which were substantial amounts of money. I opened up two other brokerage accounts before MF Global collapsed. I opened up with FCStone and have found them to be absolutely wonderful and feel the trading desk for CTAs is exceptional. I feel they have my back and are part of my team. I also have accounts at R.J. O'Brien with a commodity trading advisor who has traded these accounts for years. I started transferring my positions early in the week before the collapse of MF Global. I knew people at MF Global and was reassured that everything was in order and all was OK. Well, they probably were as surprised as I was on that Black Monday when they announced bankruptcy. The good news was that all my positions transferred to FCStone. The bad news was that not all my positions transferred to R.J. O'Brien. I had several Japanese yen trades, which ended up somewhere between MF Global and R.J. O'Brien. I was lucky as they were offset at R.J. I know traders that had opened positions and they were stuck. Money frozen and positions in which they could not exit. I was all in cash, and my cash was supposed to have been wired on the Friday before the collapse. This did not happen and my cash at MF Global was frozen.

  Considering 2011 and what transpired, I feel very fortunate. Many traders are out of business. Lives have been destroyed. My 2011 returns for my Diversified proprietary trading were down approximately 11 percent. This was one of the worst years I can recall. As much as it was a bad year, there are years that are beyond expectations. This is really what trend following encompasses. I have been able to get through all the pain over the years, and it is still a learning process.

  What this journal has done is confirm the points that I have made throughout the book. What is clear is that there are numerous small losses and small profits. There are times I stumble into some big profits, but as you can see, they are rare. The diary of my trades dispels the notion that trading is easy by a long shot. The diary shows how missing one trade can be devastating. There has not been any sugarcoating. To the contrary, there has been a lot of reality coating.

  CONCLUSION

  My goal in presenting The Trend Following Bible is to give you the ability to gain financial freedom. I have not sugarcoated anything and have given you a look at what trend following really is, no surprises. To me trend following is a lifetime strategy. It has its drawdowns and even extended periods in which profits are elusive. There will be drawdowns, there will be long periods when you do not make money, and there will be periods when you step back and say “Can you believe that?” because you stumbled onto some very large profitable trends (as rare as these are).

  I have taught you exactly how I trade. It is simple in nature but hard to do in practice. The reason it is so hard is that we all have greed and fears that we need to deal with. We as traders are the weak link. This is why a key message of the book was focusing on how to think like a successful trend follower. This is no different from what William Eckhardt and Richard Dennis taught their Turtle students. The actual trading is based on Richard Donchian's breakout strategy as well as the trend retracement ideas of Alexander Elder with a strong dose of my personal risk management so often not presented. It is simple yet effective. Most of the program was spent on how to think and how to handle the emotions of fear and greed. This is also where I have tried to lay the emphasis.

  Unfortunately, traders seek the holy grail. They seek the reasons why moves occur. They seek elusive trading indicators or trading systems. All one really needs is a robust methodology, strong risk management, as well as the need for patience and discipline for the plan to work over time.

  The patience and discipline I cannot give you. You have to do your work. You will need to believe in the methodology and follow the plan EXACTLY. My personal thought is if trend following and the trend breakout method worked for Richard Donchian for all of those decades, why would it stop working now? I know that I will have drawdowns. I know that most of my trades will not work, but I know over time I will succeed. Trend following is a marathon.

  I am here to help you in your quest to develop into a successful trader. Have patience with yourself. It is a process. You will make mistakes. You will miss trades. You will ha
ve losses. Keep in mind some of the traders mentioned in the earlier chapters of this book.

  They do not know any more than you or I. They have succeeded over time due to the fact that they have a robust trading strategy, they managed the inherent risks in trading, and most importantly, they were patient and disciplined in their trading. Sound familiar?

  I have stressed the ingredients needed for successful trading. Think of your trading education as money well spent. I am very grateful that you purchased this book. You have taken a positive step in your growth as a successful trend follower. I hope you internalize the methods described in the book. I would suggest you test these ideas in order to have absolute confidence in them. I have absolute confidence in them. You might want to apply these concepts to your own personality. I strongly suggest you do so.

  I want to thank you once again for letting me assist you in your journey of trend following.

  DISCLOSURE

  Past performance is not necessarily indicative of future performance. The risk of loss in trading futures contracts, commodity options, or forex can be substantial, and therefore investors should understand the risks involved in taking leveraged positions and must assume responsibility for the risks associated with such investments and for their results. You should carefully consider whether such trading is suitable for you in light of your circumstances and financial resources.

  Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results.

  ** The material displayed in this book is intended for education purposes only.

  INDEX

  10-year bond, trade journal

  A

  Abraham Trading Company

  Abraham, Salem

  Alan

  Alphametrix

  American Century Investments

  ArthroCare Corporation, hypothetical trade

  ATR. See average true range

  attitude

  Austin, Jeff

  average true range

  calculating

  trailing stop

  B

  Baidu

  buying

  hypothetical trade

  Baker, Jim

  Barnes, Julius

  Baruch, Bernard

  Blackwater Capital Management

  Block, Paul

  British pound trade, trade journal

  broker, need for

  Buffett, Warren

  buy and hold

  buys

  executing

  protection

  C

  Canadian dollar, hypothetical trade

  CANSLIM

  capital, need for

  Chadwick Investing Group

  charting software

  Chase, Stuart

  Chavel, Elizabeth

  Chesapeake Capital

  Clarke Capital Management Worldwide

  Clarke, Michael

  CMG, buying

  Combined Fund DCF

  commitment

  commodity futures, trading

  commodity trading, risk measures

  commodity, hypothetical trade

  Complete Turtle Trader, The

  compound interest

  compounding

  computer system

  considerations

  consistency

  control

  cool, keeping

  Coolidge, Calvin

  correlation coefficient

  Corzine, Jon

  cotton

  hypothetical trade

  trade journal

  Covel, Michael

  crude oil

  selling

  CTA Expos

  curve fitting

  D

  decisions

  Dennis, Richard

  dentist

  Dighton

  discipline

  diversified unit, trade journal

  dollar risk per contract

  commodity futures and

  Donchian, Richard

  Douglas, Mark

  drawdown

  trade journal

  Drury Capital

  Drury, Bernard

  Druz, David

  Dunn Capital Management

  Dunn, Bill

  E

  Eckhardt Trading Company

  Eckhardt, William

  The Education of a Speculator

  education, importance of

  Einhorn, David

  Elder, Alexander

  EMC Capital Management

  equity curve, stock market

  Eurodollar short, trade journal

  Eurodollar

  hypothetical trade

  selling

  executing the trade

  exiting

  expectations

  F

  fear

  losing because of

  feeder cattle

  hypothetical trade

  trade journal

  Fisher, Irving

  fixed-dollar amount risk

  follower, trend

  Forbes, Myron E.

  forex trading, risk measures

  full-service broker

  Fulton, Todd

  fundamental analysis, trend following vs.

  funding, need for

  Futures

  G

  geniuses

  Global diversified unit, trade journal

  GNI Fund Management

  gold trade, trade journal

  gold, buying

  Goodbody and Company

  Google

  Great Depression

  bear markets since

  greed

  Green Light Hedge Fund

  gurus

  H

  hard stops

  Harry

  Harvard Economic Society

  Hawksbill Capital Management

  Heebner, Ken

  Hite, Larry

  Hoover, Herbert

  HSBC

  Hull Trading

  Hull, Blair

  hypothetical trades

  I

  International Flavors and Fragrances, hypothetical trade

  introspection

  J

  Japanese equity market

  Jones, Paul Tudor

  journey, trend following as

  just take the trade

  K

  Keynes, John Maynard

  Kovner, Bruce

  L

  Lange, Harry

  LCTM. See Long-Term Capital Management

  legends

  lesson

  Leucadia

  lifetime strategy

  liquidity

  The Little Book of Trading

  Loasby, Arthur W.

  long buy potential

  Long-Term Capital Management

  trend following and

  long-term perspective

  losing, due to fear

  losses

  avoiding

  hypothetical trade

  recovering from

  low-risk trades

  Lowenstein, Roger


  M

  MACD. See moving average convergence-divergence

  margin to equity

  Marhedge

  Market Wizards

  markets, choosing to reduce risk

  McNeel, R.W.

  mechanical trading systems

  trading

  Mellon, Andrew W.

  Meriwether, John

  Metastock

  MF Global

  MFA conferences

  Miller, Bill

  mistake, by traders

  money, to start trading

  moving average convergence-divergence

  Mulvaney Capital Management

  Mulvaney, Paul

  Murphy, Eddie

  N

  NASDAQ

  NASDAQ 100 futures contract, trade journal

  natural gas, trade journal

  necessity, of broker

  Netflix

  buying

  selling

  New Market Wizards

  Niederhoffer, Victor

  O

  Olympic athlete

  open trade equity

  optimization

  overconfidence

  P

  pain

  Parker, Jerry

  Paulson, John

  Pearce, E.A.

  percentage risk, changing

  perception

  perseverance

  perspective, long-term

  Pioneer Futures

  Pit Bull

  pitfalls, trading

  plan

  following

  risk and

  portfolio risk

  position sizing

  probabilities

  profession, trading as

  profit

  profit potential

  protection

  pullback, identify

  R

  retracement, identify

  Reynolds, Arthur

  rich, wealth vs.

  risk management, elements of

  risk of ruin

  formula for

  risk

  choosing markets to reduce

  commodity trading

  forex trading

  plan and

  portfolio

  sector

  trade

  of trend following

  Robertson, Julian

  Roosevelt, F.D.

  Royal Bank of Canada

  hypothetical trade

  selling

  ruin, risk of

  rule of

  S

  S&P 500, trade journal

  Saxon

  Schwager, Jack

  Schwartz, Marty