(For demonstration purposes only. Not optimized for profitability. Trade at your own risk.)
Hold – AGI, BPI, DMC, BEL, SCC
With at least one stop loss/exit under our belts, and a whole bunch of trading entries, you can pretty much go through the entries this month and have a basic idea of what it’s like being a trend-follower. These systems aren’t much in the way of brilliance or creativity. They’re simple but they work. I think, in spite of the speed of technological progress, there will remain a place in trading for trend-following systems. Wheels, for example, still play a very useful role in the modern world despite being a primitive tool. We see them as parts of modern machines like cars and airplanes.
Backtesting has already shown how some of the most profitable trend-following systems may, in fact, be humanly impossible to trade (98-99% drawdowns! Who in their right mind could tolerate such a loss and still believe in their mechanical trading system?). I think some of the brilliant traders of today could be using trend-following systems as a basic part of the larger whole of sophisticated automated trading systems.
No system is foolproof, however. Remember how I like to compare the financial markets to casinos? And how trend-following systems remind me of the “house rules” casinos impose in order to extract profits via a “house edge” in various games? Well, casinos have to be on the lookout for extremely skilled players (such as blackjack card counting teams) and outright cheaters. Similarly, there are markets and financial instruments which shouldn’t be traded via trend-following systems. Actually, stocks, with their potential to become choppy in times of big disclosures, tend to trend less well than commodities. Indices tend to be even more erratic.
Take a look at the past 30 days trading of the KOSPI. Higher highs and lower lows. That’s a pattern, if you’re using a typical channel breakout/breakdown system, that can be most painful for trend-followers. If you see a market that likes to make a lot of higher highs and lower lows, in that order, over time, you may want to avoid using a trend-following system to trade them. They will generate too many false buying signals and trigger too many cut loss stops to be worth your while.
Richard Dennis and William Eckhardt predicted the declining profitability of simple trend-following systems. From personal experience, they do still work. However, it’s important to use parameters that are attuned to one’s risk tolerance and investment horizon. It’s also important to understand why and when they work (and why and when they don’t).
Just keep an open mind. Keep your wits about you even if you use a mechanical trading system.
Before I sleep, there is one more thing….. Elements of classical trend-following can be profitably used in commercial trading of many generic commodities (and I don’t just mean non-deliverable forwards and contracts, I mean the real things). But unlike in modern financial markets, the classical structure or build of trend-following systems cannot be used without modification. Among other things, foreign exchange trends, seasonality, fundamental, credit and social factors come into play.
Thanks for reading!