Trend Following

Cole Wilcox and Eric Crittenden of Blackstar Funds, LLC authored a white paper titled Does Trend Following Work on Stocks? This paper is being released exclusively first on the TurtleTrader collection of sites.

"Money management is like sex: Everyone does it, one way or another, but not many like to talk about it and some do it better than others. But there's a big difference: Sex sites on the Web proliferate, while sites devoted to the art and science of money management are somewhat difficult to find."
Gibbons Burke

Resources for Money Management or Bet Sizing

1. Bet Sizing Article by Ed Seykota and David Druz
2. Gibbons Burke Article on Money Management (PDF)
3. Seykota Risk Management Resource
4. Kelly Formula and Data Transmission
5. White Paper by Johan Ginyard (PDF)
6. Johan Ginyard Position Sizing Interview
7. Frequency v. Magnitude White Paper
8. Web Resource for Math, Black Jack, Kelly, etc.
9. Edward O. Thorp: Beat the Dealer (PDF)
10. Kelly's Original paper, March 21, 1956 (PDF)
11. The Sharpe Ratio
12. Tutorial Risk-adjusted Return

Another resource to add? Send us an email!

Money Management FAQ

In the twenty-first century it has become fashionable to manage one's own investments, yet few traders implement disciplined, professional money management strategies. During the stock market bubble, limiting risk was an afterthought, but given the recent price action, it’s time to get serious about management of money and risk. Professional risk and money management strategies are the foundation for success. Essentially, money management tells you how many shares or contracts to trade at a given point.

Money management is a defensive concept. It keeps you in the game to play another day. For example, money management tells you whether you have enough new money to trade additional positions. Don’t confuse money management with stop placement. Stop placement does not address the how much question.

Money management is risk management. Risk management is the difference between success or failure in trading. Trading correctly is 90% money and portfolio management. Unfortunately, this is a fact that most people want to avoid or don't understand. Once you have your money management under control, your discipline and psychology is 100% of your success.

Money management optimizes capital usage. Few have the ability to view their portfolios as a whole. Even fewer traders and investors make the move from a defensive or reactive view of risk, in which they measure risk to avoid losses, to an offensive or proactive posture in which risks are actively managed for a more efficient use of capital. Trend following risk management formulas and philosophies are key to increasing profits while controlling risk.

Q. What are some issues addressed by money management or bet sizing?
A. For example:

• How much capital do you place on each trade.
• What is the heat of your trading.
• Capital preservation v. capital appreciation.
• When do you experience expectation of success.
• When must you take a loss to avoid larger losses.
• If you are on a losing streak do you trade the same.
• How must you prepare if trading both long and short positions.
• Does a portfolio of long and short allow one to trade more positions.
• How is your trading adjusted with accumulated new profits.
• How is volatility handled.
• How do you prepare yourself psychologically.
• Have you tested your bet sizing.
• More Money Management FAQ

Q. Does money management impact a decision to trade the same number of contracts or shares in all markets?
A. Yes. Money and portfolio management rules dictate the number of contracts or shares. Precise formulas set forth size. A trader who uses a constant trading size gives up an important edge in much the same way a blackjack player does when always betting the same regardless of what cards are on the table. Common single contract/share measures of trading system performance such as win/loss ratio, percent winning trades, etc. are of little value to decision-making when using trend following systems (and the turtle system). Often the best trading approach, when tested on a single contract/share basis, will turn out not to be the best approach when money management strategies are incorporated.

Q. What about short term trading? Isn't short term less risky, and therefore you don’t need money management strategies?
A. Short term trading is not, by definition, less risky. Some people may mistakenly apply a cause and effect relationship between using a long term strategy and the potential of incurring large loss. They forget profit and loss are proportional. A short term system will never allow you to be in the trend long enough to achieve large profits. You end up with small losses but also small profits. Added together, numerous small losses equal a big loss. When you trade for the long term, you have a more positive expectation in terms of the size of the move. In the big picture, the larger the move, the larger the validation of the move. If you were trading some short term pattern predictive system you would never be able to participate fully in the big trends. Big trends make the big profits.

Q. How does money management impact drawdowns?
A. All systems have drawdowns. You can't have a profitable methodology, without taking some calculated risks as well as some losses. Trend following drawdowns are a function of the risk level desired. Risk level among trend followers varies depending upon the size of the profit they seek. For example, if you sought 100%+ a year gains you must be prepared for the possibility of a 30% drawdown. Anyone who promises you can make 100%+ with only the possibility of a 5% drawdown is lying. More on Volatility.

Q. Can you manage margin issues?
A. Required margin has little to do with money management considerations. For example, if the margin was dropped from $5000 to $2500 on a particular stock or commodity, must you trade twice as many shares or contracts? Of course not. Margin issues are not money management.

Q. Is slippage a concern with money management?
A. No one wants bad fills. But trend following for the long term places far less emphasis on perfect fills for success. In contrast, short term traders' transaction costs and skids on their fills affect their bottom line to a much greater degree.

Q. What is the win/loss ratio of trend following management? Can it experience many losses in a row?
A. Trend following systems (and the turtle system) trade for the outsized large move. Several big trends a year are your key to success. The strategy cuts your losing positions quickly. Consequently, a few big trades will make up the bulk of your profits and many small trades will make up your losses. Winning trades can range from 35-50%, but that percentage reveals little information since we expect more losses (of smaller value) than winners (of much larger value). Win/loss ratio, while a favorite of the novice trader, has limited use in terms of trend following analysis.

Paul Tudor Jones

The photo in the background of Paul Tudor Jones' office says it all: Losers average losers. Jones' wisdom was obviously lost on James K. Glassman judging from the following excerpt from his Washington Post investing column:

If you had Enron in your portfolio and didn't sell it at $90 or even at $10, don't feel embarrassed. As Alfred Harrison, a money manager at Alliance Capital Management Holding LP, which owned a ton of Enron, put it, 'On the surface it had always seemed to be a fairly good growth stock. We bought it all the way down.'

Glassman and Harrison are both dead wrong. You must feel less cash in your pocket if you average losers, not just embarrassed. Harrison violates a cardinal rule of trend following trading. Even worse, as an active money manager for clients, he admits to averaging losers as a strategy. If the trend is down, it's not a buying opportunity. It's a selling opportunity or a "time to go short" opportunity.

The absolute wisdom is on a simple piece of paper hanging right behind Paul Tudor Jones' head: "Losers average losers". Think about it.

Starting Capital

More on Capital

"...winning traders can only profit to the extent that other traders are willing to lose. Traders are willing to lose when they obtain external benefits from trading. The most important external benefits are expected returns from holding risky securities that represent deferred consumption. Hedging and gambling provide other external benefits. Markets would not exist without utilitarian traders. Their trading losses fund the winning traders who make prices efficient and provide liquidity."
Lawrence E. Harris (homepage)
Chair in Finance, University of Southern California

Download the PDF. This free report is about zero-sum trading, the single biggest reason trend followers win. In the long run, winners profit from trading because they have some consistent advantages allowing them to win slightly more often and, upon occasion, far larger profits than losers. Trend following provides those consistent advantages.

"If you make a bad trade and you have money management you are really not in much trouble. However, if you miss a good trade there is nowhere to turn. If you miss good trades with any regularity you're finished. For example, let's say the market moves rapidly through your buying zone and you miss it, you miss your buy signal and instead wait for a retracement to maybe buy cheaper. But, the market just keeps going higher and higher and never retraces. Now what do you do? There's a great temptation to reason that now it's too high to buy. If you buy it now you'll have an initiation price that's too high? No, the initiation price simply won't have the kind of significance you suppose it will have after the trade is made. You can't miss these trades. Trading systems force discipline to make sure these trades are not missed."
William Eckhardt

There are two traders. They each have:

• The same amount of capital.
• The same tolerance for risk.
• The same trend following system.

What must they do? They must both trade exactly the same. What do we mean? If two traders are essentially equal then there is neither room nor reason to act differently. Successful trading requires precision and discipline. There is no room for ego, personal opinion, subjective interpretations or emotion.

No Memory

Do not try to recoup your money. Trade for today, not yesterday. Trade what you have now. Since you can't change the past and you can't change the market, don't let your past trades determine what you trade today. Take Cisco. Many people rode Cisco straight up and they made a fortune. Many of those same people rode Cisco right back down and lost most of it. Were there sure signs to sell Cisco after it peaked? Yes. There was the falling share price. However, once people became fixated on Cisco with fond memories of how much they made originally and how good winning felt, they could not stomach accepting a loss, any loss. Instead of following a system and selling Cisco after it peaked, they elected to keep holding on in the hopes that it would come back. As Cisco continued on its death spiral their focus was still on the past as they asked themselves, how do I get my money back in this one stock?

Do not try to take revenge. Why do you have to get even with the market on this one stock? No one cares that you lost money but you. Trying to recoup in the one stock that sank you is not a strategy. It's an emotional attempt at revenge that is doomed to fail. You can't get revenge on the market. Trade for today, without regret, without wishful thinking, without anger. Trade by following a system.

Entry Is Not the Key

William Eckhardt once offered:

Suppose two traders, A and B, who are alike in most respects except the amount of money they have. Suppose A has 10% less money but he initiates a trade first. He gets in earlier than B. By the time B puts the trade on, the two traders have exactly the same equity. The best course of action has to be the same for both of these traders now. Mind you, these traders have very different entry prices. What this means is that once an initiation is made, it does not matter at all for subsequent decisions what the entry price was. It does not matter. Once you have made an initiation, what your initiation price was has no relevance. The trader must literally trade as though he doesn't know what his initiation price is.

Staring at your Bloomberg all day is counterproductive. A useful anecdote from Schwager's interview with Seykota:

Jack Schwager: I notice there is no quote machine on your desk.

Ed Seykota: Having a quote machine is like having a slot machine on your desk - you end up feeding it all day long. I get my price data after the close each day.

Here is Richard Donchian's timeless view from over 30 years ago:

If you trade on a definite trend following loss limiting-method, you can [trade] without taking a great deal of time from your regular business day. Since action is taken only when certain evidence is registered, you can spend a minute or two per [market] in the evening checking up on whether action-taking evidence is apparent, and then in one telephone call in the morning place or change any orders in accord with what is indicated. [Furthermore] a definite method, which at all times includes precise criteria for closing out one's losing trades promptly, avoids...emotionally unnerving indecision.

Superfund CEO Christian Baha

Many people think that you can't start a new trend following firm today. They think there is too much competition. Christian Baha thought differently in the mid 1990s and now today his firm Superfund is a billion dollar plus trend following firm. Nearly 10 years of impressive returns have given Superfund a worldwide client base.

Firm Disclosure:

Superfund's origin dates back to 1991, when Christian Halper and Christian Baha developed a software system for the technical analysis of financial data. Within two years, this program became the leading provider of market delivery software in Austria. This success led to the development of the Quadriga Investment Group, created by Christian Baha in 1995. Today, the group has more than 280 employees worldwide. The quadriga Group launched its first alternative investment product for private investors on March 8, 1996 called the Quadriga Beteiligungs - und Vermogens AG". In 2003 the Quadriga funds were globally unified under the umbrella brand name SUPERFUND. Today, the group has more than 1.5 billion dollars under management from more than 55,000 retail and institutional investors.

Superfund Home Page

Superfund Prospectus

Superfund (Quadriga) principals include: Christian Baha and Christian Halper.

Like the famous movie line from Cool Hand Luke, trend following has been hurt by a failure of communication. The skeptics have not been shown the facts. The evidence has not been forced upon them. Our entire web site solves that failure to communicate -- for those receptive to the message.

Why has trend following been the best style of trading for the past 30 years? Trend following has worked in the past, excels today and will perform into the future for the simple reason: trends exist and they can be traded up and down for profit.

The world will always face constant change and no one can forecast a trend’s beginning or end until it becomes a matter of record, just like the weather. But if you have a basic strategy that's sound, you can take advantage of market changes to make money by capturing the bulk of a trend. Trend following is based on good business principles. If your principles are designed to adapt, the changing world is not going to materially hurt you. It’s the ability to adapt that allows trend following to continually pull profits from the marketplace.

The Search for the Grail

"We love volatility...for being on the right side of moving markets is what makes us money. A stagnant market in any [market]...means there's no opportunity for us to make money."
Dinesh Desai

Some people are skeptical. They come to this web site seeking the magic bullet, the Holy Grail, the secret sauce -- they miss the clear point. There are no secrets. There is only hard work.

What are wrong views of the market we hear from readers?

1. My trading style tells me when the market will follow through.
2. The markets have changed.
3. Trend following has changed.
4. Profit targets are wise
5. Short-term technical analysis that predicts direction works well.

How would trend followers respond?

1. You can not predict a follow-through of a market trend.
2. The markets have not changed. Trend following has not changed either. New? Don't believe the hype.
3. The fact some one trader did poorly has to do with that one trader's greed/fear profile, not trend following.
4. Trend followers all trade in a similar fashion.
5. Profit targets are prediction. Set a profit target and you miss trends by exiting early.
6. Turtle trading is for stocks too.
7. There is no trading technique that can predict market direction.
8. Danger!

Big trends are like epidemics. Starting with only a few people, an epidemic can spread through a population as it multiplies again and again. Just like when a virus spreads, it doubles and doubles and doubles. It flows. It trends.

Extreme market trends can appear from out of nowhere moving either up or down. These trends often feed upon themselves and can quickly progress geometrically allowing the opportunity for huge profits if you traded the trend. However, people can have a hard time with this idea, because, like an epidemic, the end result often seems out of proportion to the cause. Instead of just riding the trend for profits, they seem more interested in understanding it. Instead of wanting to win, they want to be right.

In order to appreciate why market progressions or trends can be so powerfully rewarding, you must not expect proportionality. You need to prepare for the possibility that sometimes big market changes follow small events, and that sometimes that change can happen very quickly. Trend following trading is designed to find and exploit those market trends long before they arrive on the radar screen of the masses.

Impatience v. Wisdom

"We know that prices move up and down. They always have and they always will. My theory is that behind these major movements is an irresistible force. That is all one needs to know. It is not well to be too curious about all the reasons behind price movements. You risk the danger of clouding your mind with non-essentials. Just recognize that the movement is there and take advantage of it by steering your speculative ship along with the tide. Do not argue with the condition, and most of all, do not try to combat it."
Jesse Livermore

A few years back one trend follower decided he would start trading the S&P from a discretionary standpoint. He nearly lost it all. That's right he put aside rules, that he knew worked, and started trading without a system. Why did he do this? Who knows. But does it say something about the individual trader's greed/fear OR the rules? Systems don't make up for poor personal discipline. They are only as good as the individual adhering to the principles.

The wisest man TurtleTrader knows has offered that every 5 years some famous trader blows up and everyone declares trend following to be dead. Then 5 years later some famous trader blows up and everyone declares trend following to be dead. Then 5 years later...well the point must be clear now. The turtle above was probably noted in the press as one of those traders every 5 years, but the reality of why he had problems was himself, not trend following.

More on Why Trend Following Works

If you have a valid basic philosophy, the fact that things change turns out to be a benefit. At least you can survive. At the very least, you will survive over the long term. But if you don't have a valid basic philosophy, you won't be successful because change will eventually kill you. I knew I could not predict anything, and that is why we decided to follow trends, and that is why we've been so successful. We simply follow trends. No matter how ridiculous those trends appear to be at the beginning, and no matter how extended or how irrational they seem at the end, we follow trends.
John W. Henry

It's probably the question we get asked the most, and it's definitely simple to answer: Have the markets changed? No. Markets behave the same as they did 300 hundred years ago. They are the same today because they always change. If you have a trading system that's sound, meaning its principles are designed to adapt, you can take advantage of market changes and make money. Changes in markets are no different than changes in the business world, or in life. They will not impact negatively on you if your strategy for handling them is based on reality, flexibility and responsibility for making your own decisions.

Still others are unconvinced and argue that technology erases any trading edge, thereby changing the markets. Computers don't erase edge. For every trader with a computer program saying buy, there are nine other traders with computer programs saying sell. No matter what you do, markets go through different stages: accumulation, run up, distribution and run down. But, the belief that markets have changed (and rendered trend following dead) is vacuous thinking.

More on Change 1

More on Change 2

More on Change 3

More on Change 4

Extraordinary Popular Delusions and the Madness of Crowds is a good read for those that feel the market today is different than the past.

This website was named TurtleTrader® and the phrase "turtle trading" was coined by Michael Covel because it described a great story about how a group of non-traders were taught to trade for big profits. Some of these original TurtleTraders have continued to be successful while others have failed in grand fashion. Jack Schwager's 'Market Wizards' books originally positioned these traders as winners all, but secretive and reluctant to share their so-called "secrets" with the world. Today, TurtleTrader remains the ONLY independent voice on this subject revealing the pros, cons and myths. If you want to know the true story, if you want to know the exact lessons, we are the only source to help your education. The following (2) books paint a true picture of trend following trading and the turtles:

The Complete TurtleTrader (Collins, 2009).

Trend Following (Pearson, 2009)