A lesson from the past - letting profits run

Last night, myself and another trend following trader were keeping ourselves amused by observing a trading thread relating to a US stock which had shot up on some positive news. The chart of the stock in question is below:

Some familiar names here...

On this page you can look at the monthly performance for some of the most successful CTA's. Looking at this list, it's funny how many names near the top are trend followers, former members of the Turtles programme etc, and that also the majority of those names are amongst the longest established funds on the list.

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Cut losses short and let profits run,
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Develop the correct trading mindset.

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So, what are your excuses - and will you do anything about them???

When a trader who is struggling to become profitable loses on a trade, or on a series of trades, what is their usual response? And how does it differ to when a long-term successful trader suffers a loss or a drawdown?

Well, most successful traders have long since eliminated any errors, repeated mistakes or psychological issues that may have held them back in the past. They take full responsibility for their own actions, and the consequences of those actions. They also know that, how they react to the results of any prior actions will have a direct impact on how they think and feel going forward.

Sometimes you win by losing (small)...

Below are some charts of US stocks where attempted entries in early December very quickly failed (they are shown on the trades list). Taking those small losses as per our rules was unquestionably the right thing to do. Sure, you can get whipsawed out of a position, but we can always re-enter if price subsequently triggers a new entry.

Remember, we look to enter as soon as possible on a price breakout. On a long trade, if price falls back below that breakout level, then the breakout has failed, and the reason for remaining in the position no longer remains valid. Hence, we cut our losses very quickly.
 
In How to Trade in Stocks, Jesse Livermore talked about this very point:

Well, I did say...

In this recent post, I talked about how trend followers can suffer a drawdown or a period of non-performance seemingly for months, only for things to suddenly turn around. This isn't just particular to me, but is what all trend followers have to go through on a periodic basis.

Well, after suffering what seemed to be a never-ending run of losing trades over the last few months, I've managed to get into a couple of profitable trades, of which one in particular has started to trend nicely.

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How a trader's approach to risk can change

"There are old traders and there are bold traders, but there are very few old, bold traders." - Ed Seykota

When the vast majority of people start trading, getting the perfect entries and exits dominate their thoughts. Little or no regard is given to risk. All they are concerned about is the potential rewards -  how much money they can make, and the sooner, the better.

If they somehow manage to survive this initial period, they will start becoming accustomed to risk control dominating their thoughts. At this point, they may occasionally resist, but with some larger than acceptable losses (either by risking too much, by overriding an exit signal, or by taking on too many trades at one time), they start to learn - the hard way. The realisation dawns on them that, if they don't improve their risk control, they won't be in the game for much longer.

Trading needs commitment

If you want to achieve success as a trader, you need to be committed to the process. Trading is something that you cannot go into half-heartedly. It is your hard-earned money that is on the line. It is you that makes the buying and selling decisions. It is you who determines how much you risk on each trade. It is you who decides how to react or respond to things that have occurred in the markets and your own trading.

If you have read interviews with people such as those featured in Market Wizards, those individuals became so engrossed in trading that it took over their whole life, and ultimately became a lifetime's endeavour. Yes, that is a big price to pay, but then the potential rewards are huge as well.

One good trend pays for them all

While still getting stopped out of a couple of trades this week which were at one time in profit, a couple of long positions have started to try and gain traction, combining for a current open profit in excess of 4R. While those gains can easily be lost in a day, it is nice to see some profits on my screen!

As Ed Seykota was fond of saying, "One good trend pays for them all!". Should a decent trend start to materialise, then it is quite possible that the run of losses suffered could easily be eliminated. Such is trend following.

Trend following is child's play!

Children have a wonderfully uncomplicated view of things. What they say and think is based on what they see, and as we grew older we tend to lose this skill. 

Trend following is a very simplistic method of trading. A good set of trading rules should be able to be written on the back of the proverbial cigarette packet, or on the reverse of a business card. If you can't then its too complicated.

A review of the R curve

Below I've shown my R curve performance, which I believe is a better representation of current performance than pure equity.

As I use fixed fractional position sizing, I risk a fixed percentage of whatever my closed equity is when opening new trades.

As it is clear to see, and has been borne out on enough recent blog posts, my performance has not been great over the last few months. However, I've been trend following long enough to know that, just like price on an individual stock, equity curves do not go straight up. There are bumps along the way, regardless of who you are, from someone trading a small amount in their study to the hedge fund stars of the last 30 or 40 years.

Unlock your potential!

When trading, you need a combination of the following elements to be present to achieve long-term success:

• A robust method with a positive expectancy;
• A strong appreciation of risk control;
• A strong mind allowing you to have the patience and discipline to trade the method as intended.

Quite often, you may have one or two of those elements in place, but are lacking in the remaining area(s). This can lead to frustration and losses. In some cases, it could lead you to ditching a particular trading style or timeframe, when they might not actually be the root cause of all the frustration.

Getting out on time

I've posted this chart up as an example to show you why you should always heed any exit signal you get to denote a trend has finished.

This is a UK stock, which formed a great set up during October, and then sprang into life in November. The trend stalled and then generated an exit signal at the beginning of the month.

Some people might have been tempted to hold on, thinking this was just a pull-back within a major uptrend. That might still be the case, and will depend upon your timeframe and parameters, but how big a pullback do you want to suffer before you throw the towel in? If you do hang on and override the exit signal given, who's to stay that price will completely reverse trend again back to the downside?

Reaping the rewards

It's been a pleasure to see a number of members in our group doing so well this week. What have they done? Simple:

• They identified stocks that were setting up per their entry rules. This was based on price action and what the longer-term trend was;
• The entered without question when the appropriate entry signal was made;
• Most importantly, they have had the patience and discipline to let those trades play themselves out.

Now, in most (but not all) of these cases, these have been short setups. These positions have been initiated over the last few weeks, on UK, US and other worldwide stocks, even when the general market has been at or close to all-time or multi-year highs.

In other words, they have concentrated on what price action has been telling them on the stock they were intending to trade, not what other stocks, or the general market was doing.

Do the maths

A long-term trend which may have developed over several months may look huge on a price chart. The price in an individual stock may have appreciated 100% - maybe more. And that's great. A lot of traders trumpet their own trades in this manner. But that's not what I'm interested in.

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More details are here.

The grim truth

There's no getting round it - when you are in a losing run of trades it's not much fun. As Tiger Woods is fond of saying "It is what it is".

Speaking to a few fellow traders over the last couple of weeks, and generally looking around, there are other traders who work using a similar style to my own who have also struggled somewhat, despite the general markets being near their all time highs.

All this highlights is that trading is not easy - if it was, everyone would be raking in millions.

Some decent trends going against the general market

While the major indices have been continuing to be at or near to all-time or multi-year highs, some stocks have been steadily trending in the opposite direction for a while.

I talked in this post about paying less attention to the general market movements going forward, and more on the longer term trends within the stocks I am looking to trade. And, as I point out in my e-book, if the market is going one way and a stock breaks out in the opposite direction, this can be a great potential opportunity.

My plan for 2015

Trend following is an absolute returns approach. As a result, I have no benchmark to work or compare my returns to, such as an index. While you attempt to limit the downside as far as possible, there should be no limits as to how much you can make as a trend follower.

With that in mind, I am already getting ready in adjusting my overall trading plan ready for 2015. Some of these points have already been discussed in recent posts, however, this post will attempt to summarise the changes.

A current example of exploding profits

Earlier this week I received an update from a trader based in Australia who is part of our mentoring group. Now, this guy has already had the experience of a run of losses, which were more than covered by one big win (see here for more). With his permission, below are some extracts from his latest email:

"You aren't wrong about getting onto winning trades, I've been having a pretty good time of it lately, incredible gains this past 3 days!

Aside from CNU, which is +8.5R, I'm also short in MRM and SKE for another +8R (NB: charts are below).
 
Trading has almost become an obsession now.... Aside from the scans, for the past few months, I've been looking for trade ideas wherever I can find them, and then bringing them back into 'our' world to see if they make sense. Admittedly most are rubbish but some work out. CNU came from the scans and I think MRM also. SKE the chart looked good.

A salutary lesson about risk

Here's an extract from an email from a trader about a recent losing trade. This is a great example of why risk control is paramount in your overall trading approach:

"But now to what I have called my 'Greego' (Greed / Ego) trade in gold. I took a short position in gold but as it's minimum 10 contracts the risk was slightly too big (I knew this but did it anyway). The trade immediately went my way (wow I'm a hero...) so I shorted again (the risk was much too high, knew it and did it anyway. i.d.i.o.t).

Acting in the moment of now

Think for a moment about your trading, in particular how you respond to past events, or letting your mind drift into the future. Then ask yourself a couple of questions:

• Do you fret or stew over what has happened in the past, be it trading errors, losses suffered etc?
• Do you worry over what you perceive may happen tomorrow, next week or next month?

If you answer yes to either (or both) of them, then I've got news for you:

• What's done is done. You can't change it.
• Also, what's the point in worrying about the things in the future that may never happen?

In both of these scenarios, you cannot control or influence anything.

Instead, do something positive, and on which you CAN control or influence - focus on the moment of now.

NEW - Improvements to the mentoring programme for 2015

As seen in these testimonials, participating in the mentoring programme has helped a number of traders to eliminate the destructive mistakes that can lead to significant drawdowns or even account blow ups, help them start to consistently generate profits in the right market conditions, and to keep losses to a minimum when conditions are not as favourable. This does not simply concentrate on entries and exits, but also on the vital factors of good risk control and trading psychology.

I have always placed great belief in working as a team can help everyone. This has generally worked well on the members twitter feed, but this is somewhat limited as a medium when it comes to detailed discussions. I also keep an eye out for additional ways where I can add value, wherever possible.

Risks and rewards

There are plenty of people out there who are attracted towards a particular method of trading or investing, and who believe they can ride out periods of non-performance or a drawdown, in order to achieve the longer-term returns that are possible.

This is particularly true of trend following. There are countless examples of trend followers who have significantly outperformed all benchmarks over the long haul, yet in order to achieve this they have had to endure periods where things haven’t gone their way.

Top blog posts from the archives

As we are now in the last month of the year, there will no doubt be plenty of top five or top ten lists going around. Well, I thought I'd beat the crowd and get in early. I'm not a marketing whizz, so these posts do not have eye-catching titles. But the content is what is important to me, and to other traders. I've ignored any posts relating to examples of winning or losing trades - these focus on ideas that may help you as a trader, or focus your mind on what is important to a trend follower.

So, below are the top 5 posts (in terms of page hits received) from the blog archives: