Many investors at one time or another have heard of trend trading but most don't really know what it means or how to start. In the mighty words of Wikipedia, "Trend following is an investment strategy that takes advantage of long-term moves that seem to play out in various markets" but isn't that what most long-term investors strive to do? What Exactly Makes an Investment Strategy a Trend Trading Strategy? By definition, when you are a trend trader, you follow a trading system and you stick with it for the duration that your system requires. It's pretty simple, really: You create or find a system that you trust to be successful over a length of time. You get to the point of trusting that system because you, or whomever has created the system, test and back-test the numbers until you reach the point that you can be certain that your system will make money. The most important thing is to stick with that system, no matter what. Easy to summarize, but a bit tricky to execute. Don't get me wrong, trend trading isn't rocket science. It is a tried-and-true investment strategy that has made billions of dollars over decades. It uses various indicators to determine market trends and benefit from both sides of that market, enjoying the profits from both ups and downs of the markets. This up and down movement, the volatility, is what makes successful trades, rather than how well the market is doing on a given day. We all have an idea in mind when we hear the word "trend," but for investing, it's about much more than what is "hot" at a given time like Fall Fashions or current video games. It's more about sticking with your system and it's trends, as it is about spotting a trend. It's about finding a system you trust, sticking with that system no matter what until you ride out the trend, and you can make profits similar to world class hedge funds. For example, Warren Buffett is a very famous trend trader and it's not unusual for large funds to make over 1000% profits. Really. Decades of Proven Profits Trend following has been strongly documented since the 1950's when Richard Donchian published a trend following newsletter that became very popular and it got popular again when the book Market Wizards: Interviews with Top Traders (written by Jack D. Schwager) came out. One of the most famous stories ever that circulates among traders is documented in this book and it's about "The Turtles." Many known trend traders today are associated with the Turtles or try to emulate them. The story of the Turtles is actually very similar to "My Fair Lady" whereby a professor bets a wealthy gentleman that he can take a lower-class woman, pop some nice clothes on her and teach her to speak correctly and use proper diction, and she will pass as an upperclass woman. The wealthy man is aghast at this and declares it can't be done. Needless to say, it can be done and Audrey Hepburn marries the professor. So in the case of "The Turtles," two well-respected (read: successful) traders had an argument over learning to trade. One trader said that great traders were born and not made, while the other trader, Richard Dennis, said people could learn how to trade and do well. So they made a bet - for $1.00. Then they got a small group of 14 people together, 12 men and 2 women - most of whom had never traded before - and taught them a simple trading system. They provided them with 2 weeks of training, then gave them money to trade. Four years later, the turtles had made over $200,000,000. Richard Dennis, the trader who said that trading could be learned, won the bet. He is one of the most famous trend followers today. Trend trading can be taught, it can be learned, and it can make boatloads of money. The amazing thing is the actual rules of any trend trading system are simple to learn. It's not rocket science. The difficult part is to consistently follow your system. That means being patient, being diligent, and not being emotion with your trades. Even that isn't all that hard. And its hugely easier to follow a system when you know you're doing the right things, in the right order, at the right time. So the summary of trend trading is, if you are looking to make money trading, you need a system that makes money, and you need to know you can be taught how to use that system.There aren't any secret techniques or hidden tricks or voodoo that make trend trading work. You just need a set of teachable (and learnable) techniques. Current Proof of Trend Trading Profits A great resource that to determine which traders or funds use trend trading systems is the website, http://www.autumngold.com Traders use this site to see what their competition is up to. Check out the website and search for "trend following managers"… look at their returns. Then look around and see the returns for some of these guys. This website shows real-time proof that professional traders are profiting right now. They're making billions of dollars right now and so can you. How Much Do I Buy And Sell to get these Returns? Exactly how much to buy or sell is based on the size of the trading account and the volatility of the market. Adverse price movements signal an exit for the trade. Traders usually enter the trade after the trend establishes itself, and, for this reason, they ignore the initial market turning point. If there is a market turn against the trend, the system has a pre-programmed exit in place at all times. This is something especially to look for in a good system. The system then waits until the turn establishes itself as a trend in the opposite direction. In case the system signals an exit, the trader re-enters when the trend re-establishes. Your system let's you "ride out that trend." What About Volatility? Volatility, this up and down movement in the markets, is what makes you the money. Trend Traders use current market price calculation, moving averages and channel breakouts to determine the general direction of the market and to generate trade signals. Traders who employ a trend following strategy do not aim to forecast or predict specific price levels; they simply jump on the trend and ride it. And Don't Forget Risk Management Trend following is most commonly associated with technical traders and involves a risk management component that uses three elements: 1. number of shares held, 2. the current market price, 3. current market volatility. The most important thing you want to remember concerning risk management is that you want to trade only 1-2% of your account with each trade. This keeps your losses at a minimum, because there will be losses as there is with any type of investment strategy, but you don't risk losing your entire account with any given trade. I've seen traders wipe out their entire accounts in a day- trend trading done correctly avoids this risk. An initial risk rule determines position size at time of entry. Exactly how much to buy or sell is based on the size of the trading account and the volatility of the issue. Changes in price may lead to a gradual reduction or an increase of the initial trade. On the other hand, adverse price movements may lead to an exit for the entire trade. A good Trend Following system tells you: • How and when to enter the market. • How many contracts or shares to trade at any time. • How much money to risk on each trade. • How to exit the trade if it becomes unprofitable. • How to exit the trade if it becomes profitable. Whether you are creating your own system or are purchasing one, these are the things you will need to know to make your trades. You should also have access to enough back tested data to verify the system's claims of profitability. And remember, keep your trades small always. Trend trading is a great way to make a lot of money. The most money is in Futures Markets, but you can apply a trend trading strategy to stocks, currencies, practically anything. The potential profits are out there. Copyright (c) 2012 Trend Following 101 Michael Sankowski, lives in Oak Park, IL and when not playing the guitar, has been a professional trader for 20 years. He's traded billions of dollars on four continents and is a well-known financial writer. He's a CFA, CAIA, and has created patented Futures products. His site is Trend Following 101 which sells premium trend trading products.
"The Golden Rules of Trend Trading (DOC)"