Trend Following. Ritholtz Barry

if you want positive returns every month, well, you could have had your money with the Ponzi scheme of Bernard Madoff and his fake monthly 1 percent performance, but you know how that turned out. You can’t make money if you are not willing to lose. It’s like breathing in, but not willing to breathe out.59

      Think of it this way: If you don’t have losses, you are not taking risks. If you don’t risk, you won’t ever win big. Losses aren’t the problem. You must always cut them. Ignore losses with no plan, let them build up, and they will come back to wipe out your account.

      Theoretically, really big losses rarely befall trend following strategy because it eliminates or reverses positions as soon as the market goes against it. The rationale for hanging in is that any price move could be the beginning of a trend, and the occasional big breakout justifies a string of small losses.60

      Surf the Waves

      I am fortunate to have learned from trader Ed Seykota starting in 2001 with our first Virgin Islands meeting, through a 2012 panel with Larry Hite, and up to his 2016 podcast appearance. But early on he told me a story about being in Bermuda with a new trader who wanted secrets. “Give me the quick-and-dirty version of your magical trading secrets,” the neophyte beamed.

      Seykota took the new trader out to the beach. They stood there watching the waves break against the shoreline. The newbie asked, “What’s your point?”

      Seykota said, “Go down to the shoreline where the waves break. Now begin to time them. Run out with the waves as they recede and run in as the waves come in. Can you see how you could get into rhythm with the waves? You follow the waves out and you follow them in. You follow their lead.”

      The truth of trend following is its philosophical underpinnings are relevant not only to trading, but to life in general, from business to personal relationships. The old-pro trend followers were clear with me, in their words and actions: Trend following works best when pursued with the right mindset and unbridled passion.

      First, consider the role of proper mindset. As Stanford psychologist Carol Dweck teaches, “In a fixed mindset, people believe their basic qualities, like their intelligence or talent, are simply fixed traits. They spend their time documenting their intelligence or talent instead of developing them. They also believe that talent alone creates success – without effort. They’re wrong. In a growth mindset, people believe that their most basic abilities can be developed through dedication and hard work – brains and talent are just the starting point. This view creates a love of learning and a resilience that is essential for great accomplishment. Virtually all great people have had these qualities.”61

      Second, trading coach and psychologist Brett Steenbarger argues the passion point: “Find your passion: the work that stimulates, fascinates, and endlessly challenges you. Identify what you find meaningful and rewarding, and pour yourself into it. If your passion happens to be the markets, you will find the fortitude to outlast your learning curve and to develop the mastery needed to become a professional. If your passion is not the markets, then invest your funds with someone who possesses an objective track record and whose investment aims match your own. Then go forth and pour yourself into those facets of life that will keep you springing out of bed each morning, eager to face each day.”62

      In my experience it became crystal clear when used within the context of mindset and passion, the term trend following can be substituted in this edition for other aspects of life. That insight crystallized in a passage from Brenda Ueland’s 1938 book on creative writing: “Whenever I say writing in this book, I also mean anything you love and want to do or to make. It may be a six-act tragedy in blank verse, it may be dressmaking or acrobatics, or inventing a new system of double entry accounting.. but you must be sure that your imagination and love are behind it, that you are not working just from grim resolution, i.e., to impress people.”63

      Successful trend followers don’t trade with grim resolve or with the intention to impress. They are playing a game to win and enjoying every moment of it. Like other high-level performers, think professional athletes and world-class musicians, they understand how critical it is to maintain a winning attitude for success. And as Larry Hite told me, good trend following traders ask questions:

      The first question you have to ask yourself: “who are you?” I’m not kidding. And don’t look at your driver’s license! But what you got to say to yourself: “What am I comfortable doing?” Am I an arbitrager? Am I a short-term trader? It is really important that you understand who you are and what you want to do. The next thing you have to ask yourself, one of the real details, “What are you going to do?” What are you going to do exactly? What has to be done? Is it hard to you? Is it easy? Do you have the materials to do it? One of the great things about the market is the markets don’t care about you. The market doesn’t care what color you are. The markets don’t care if you are short or tall. They don’t care about anything. They don’t care whether you leave or stay. The last question you have to ask yourself: “What follows?” You have to ask yourself, “If I do this and it works, where am I? What have I got?” Now what I’ve said may really sound like it’s pretty simple and common sense, [but think about the failed hedge fund Long-Term Capital Management] those were some very, very smart people [Nobel Prize winners] who did some pretty stupid things. And they did it because they didn’t ask themselves the basic questions.

      Armed with Hite’s marching orders let’s dive deeper into what it takes for trend following excellence.

      Summary Food for Thought

      ● Galileo Galilei: “All truths are easy to understand once they are discovered; the point is to discover them.”

      ● Hendrik Houthakker (1961): “Price changes are not purely random, but follow certain longer run trends.” Inspired by Benoit Mandelbrot, Houthakker was an early EMT critic.

      ● Ed Seykota: “All profitable systems trade trends; the difference in price necessary to create the profit implies a trend.”

      ● Prices, not traders, predict the future.

      ● If you don’t have losses, you are not taking risks. If you don’t risk, you can’t win anything.

      ● Price goes either up, down, or sideways. No advance in technology, leap of modern science, or radical shift in perception will alter this fact.

      ● What if they told you the best way to get to point B, without bumping into walls, would be to bump into walls and not worry about it? Don’t worry about getting to point B, but enjoy bumping into walls.64

      ● Trend following strategy is not for trading alone. The MIT blackjack team led by Mike Aponte (podcast episode #22) pursued very similar strategies, as do venture capitalists like Marc Andreessen. Film producer Jason Blum also uses an edge-seeking strategy to produce films.

      ● To receive my free interactive trend following presentation send a picture of your receipt to [email protected].

Author note: The following quotations appear in the hardcover side margins

      The aim is to make money, not to be right.

Ned Davis

      The people that I know who are the most successful at trading are passionate about it. They fulfill what is the first requirement: developing intuitions about something they care about deeply, in this case, trading.

Charles Faulkner 65

      Who will check the ‘fact checkers?’ Who will watch the watchmen?

Anonymous

      Too many people simply give up too easily. You have to keep the desire to forge ahead, and you have to be able to take the bruises of unsuccess. Success is just one long street fight.

Milton Berle

      A

59

“The Trading Tribe” (forum response), The Trading Tribe, www.seykota .com/tribe/.

60

Mary Greenebaum, “Funds: The New Way to Play Commodities,” Fortune (November 19, 1979).

61

Carol Dweck, “What Is Mindset,” Mindset, accessed December 17, 2016, http://mindsetonline.com/whatisit/about/.

62

Brett N. Steenbarger, The Psychology of Trading (Hoboken, NJ: John Wiley & Sons, Inc., 2002), 316–17.

63

Brenda Ueland, How to Write, 10th ed. (New York: Graywolf Press, 1997).

64

Van Tharp, Super Trader: Make Consistent Profits in Good and Bad Markets (New York: McGraw-Hill Education, 2010).

65

Robert Koppel, The Intuitive Trader (Hoboken, NJ: John Wiley & Sons, Inc., 1996), 88.