Trading Systems: Learn Trend Following

Trend following relies on money and portfolio management (or bet sizing) for success. The absolute key to any turtle trader’s (such as Jerry Parker or Paul Rabar) success is knowing how much to bet at all times. This is money management in a nutshell. More.


Keep in mind, great trading systems incorporate volatility. You can’t have a profitable methodology without taking calculated risks and taking losses. Drawdowns are part of the game. To the educated trader a drawdown is not to be feared or avoided, but rather is understood as simply another component of a successful trading system. More.


The following discussion involves three trend followers. Barbara is a former pupil of Richard Donchian, Bill is a former partner of Richard Dennis, and another Dennis student.

Barbara: If you read Market Wizards and talk with successful traders, you will find that one common trait among survivors and winners is discipline. Adherence to a trading plan is an easy way to insure disciplined trading.

Student: We believe a trading plan should represent codified common sense, experience, research, and as an absolute last resort, optimization. Of these, common sense is the most important, since it can transcend the limited time horizons of our experience and historical research.

System Trading Design

Barbara: When designing a system, I believe it’s important to construct a set of rules which fit more like a mitten than like a glove. On the one hand, markets move in trends, but on the other hand, past results are not necessarily indicative of future performance. If you design a set of rules which fit the curve of your test data too perfectly, you run an enormous risk that it will fizzle under different future conditions.

Bill: It is much more important to verify that your system is in a well-behaved region of its parameter space or to develop new macro-concepts, than to squeeze the last few drops of theoretical expectation out of your system through micro-adjustments.

Novice System Traders

Barbara: Contemporary databases, software, and hardware allow system developers to test thousands of ideas almost instantaneously. I caution these people about the perils of curve fitting. I urge them to remember that one of their primary goals is to achieve discipline which will enable them to earn profits. With so many great tools it’s easy to change or modify a system and to develop indicators rather than rules, but is it always wise? I suggest they plan their research and conduct their studies in a systematic fashion. I remind them that systems and trading involve compromise – perfection is not achievable. Finally, I suggest they move slowly, that they look at trades on charts and not simply study printouts of hypothetical profits and losses.

Student: …we believe that for a signal to be meaningful, it should be eminently understandable. We should be able to explain – preferably a priori – why something works in a few simple, logical sentences.

Trading and Compounding

There is only one way to profit in the market. You must apply a systematic approach over time, compounding as you go. Don’t be so naive to expect you will get rich overnight. Remind yourself that patience is a virtue when it comes to trend following. You must have the discipline to work within the structure of your system. For example, if you can manage to make 50% a year in your trading, you can grow an initial $20,000 account to over $616,000 in just seven years. Trust that time and the power of compounding will take over if you stick with your system. You think 50% is too unrealistic for you? Do the math again using 25%. In other words, compounding is essential.

Hypothetical investment of $20,000 (annual rates of return compounded)

  30% 40% 50%
Year 1
$26,897 $29,642 $32,641
Year 2
$36,174 $43,933 $53,274
Year 3
$48,650 $65,115 $86,949
Year 4
$65,429 $96,509 $141,909
Year 5
$87,995 $143,039 $231,609
Year 6
$118,344 $212,002 $378,008
Year 7
$159,160 $314,214 $616,944

Successful traders and investors are psychologically prepared to stick with their system through good times and bad. You will never reach your goal as a trader if you can not maintain the self discipline to trust the rules you have chosen.

General Rules for Trading Systems

  • Understand why you are trading in the markets. Are you seeking a gambling thrill or are you serious about making money?
  • Use a system and don’t deviate from it.
  • Use money management at all times.
  • Establish your trading plan before the markets open.
  • Detail your plan for each trade.
  • Establish entry and exit points and understand risk reward ratios.
  • Accept small losses as part of the game if you want to win.
  • Trade markets from the short side.
  • Maintain a strong and honest relationship with your broker.
  • Develop a business plan. Speculation is a business.
  • Stay the course so you are around for the big moves.
  • Don’t blame the market for your losses. You are the reason for your losses.
  • Develop a trading plan for each potential situation you may face.
  • Do not look at quotes during the day.
  • Do not concentrate on break-even levels when you are losing.
  • Remember that break-even levels do not impact on the future success of a position.
  • Don’t liquidate a winner to keep a loser.
  • Develop and maintain an exit plan. Follow this plan with rigid discipline.
  • Remember that greed kills.
  • Never add to a losing position. A losing position means you were wrong.
  • Sustain your patience. Big movements take time to develop.
  • Remind yourself there is nothing new in the markets.
  • Don’t predetermine your profits.
  • Avoid techniques you don’t understand.
  • Don’t be overly curious about the rationale behind a move. The key to wealth in trading is simplicity.
  • Trade money not markets.
  • Bulls and bears make money, but pigs get slaughtered.

The classic text Reminiscences of a Stock Operator published in 1923 offers timeless wisdom for all investors and traders:

Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after an investor has firmly grasped this that he can make big money. It is literally true that millions come easier to a trader after he knows how to trade than hundreds did in the days of his ignorance.

Trend Following Products

Review trend following systems and training:

Michael Covel Trend Following Products
Michael Covel Trend Following Products