The following individual is a good guy. He wants to help TurtleTrader better organize content and create new content. But his email exchanges prove he doesn’t exactly get what trend following is:

I’m ready to execute. I’d like to get moving on a sector view. I think entertainment would be a good one because of the problems at Disney and the inconsistencies at Viacom, AOL/Time Warner and Newscorp. [Also] a stock to watch [feature].

Keep in mind, this is a technical strategy. Fundamentals are poison. Inconsistencies at Disney or Viacom are not relevant. The only thing that matters is the ‘price’. There is no prediction. There is no outlining ahead of time what will happen. Trend followers never know a trend magnitude until it’s over. In terms of stocks to watch, unless those watching know exactly the strategy to use, telling them to watch is akin to David Faber offering a pick. Telling them to watch without them knowing when to sell or how much to buy or sell is problem filled. Trend following is the absolute antithesis of all Wall Street represents.

After we countered his first response, he offered:

A perspective piece on a sector: for example, within media stocks the focus seems to be on Disney. But take a closer look and the price of other media stocks are rising. Example, Clear Channel is up five percent over the past week. This article could look at stocks that have moved significantly and analyze only pricing history, current conditions in its market sector and management issues. This would provide meaningful information to experienced Trend Followers without feeding them Wall Street bullshit. It would attract potential Trend Followers by introducing a new way to look at stock pricing, not performance…Stock to Watch: Example: Nortel is still in a down pricing trend. Bad news from competitors like Lucent could continue to affect adversely.

Even when we explain no fundamentals, for some, it just doesn’t register.

Why the Second Email Is Still Wrong

The second email is more sophisticated and more difficult to address because it uses the language of price. Clear Channel is up five percent. Nortel is in a down pricing trend. These sound like price observations. But “current conditions in its market sector and management issues” is still fundamental analysis. And “bad news from competitors like Lucent could continue to affect adversely” is still a prediction. The wrapper changed. The content did not.

The specific problem with “bad news from Lucent could continue to affect adversely” is that it introduces a causal chain from an external event to a predicted price outcome. That is exactly what trend following does not do. Trend following does not predict what will cause a price to move. It reads what the price is doing and follows it. If Nortel is in a downward trend, the system is short. Whether that trend is caused by Lucent’s bad news, management failures, sector deterioration, or pure market sentiment is irrelevant to the position. The reason the price is moving is not an input into the system. Only the price itself is.

This distinction is difficult for many people to internalize because the causal chain feels informative. Understanding why something is happening feels like an edge. But the trend following edge comes from disciplined response to price movement, not from explanation of that movement. Two traders can have completely opposite explanations for why a trend is developing and both be in the correct position if they are both following price. The explanations are noise. The price is signal.

The “stock to watch” concept has the same fundamental problem regardless of how it is framed. A stock to watch implies that the reader will decide what to do after watching. But trend following requires knowing before you enter: the entry signal, the stop loss level, the position size based on current volatility, and the exit criteria. Without all four, a stock to watch is a tip with better vocabulary. Fundamentals are not the only poison. Vague price observation without a complete system is the same poison in a different container.

Frequently Asked Questions

Why are fundamentals described as poison for trend following?

Because they introduce factors that are not the input trend following uses and that can distort the decision the system is designed to make. A trend following system enters based on price movement meeting defined criteria. If the trader is also evaluating management issues, sector conditions, and competitive dynamics, those factors will influence when they enter, whether they hold through an adverse period, and when they exit. The result is a discretionary hybrid that uses the rules selectively rather than consistently. Price is the only input. Everything else is noise that distorts the signal.

Why is “bad news from competitors could affect price adversely” a prediction?

Because it posits a causal chain from a future event to a future price outcome. The statement assumes that bad news from Lucent will occur and that it will cause Nortel’s price to fall further. Both are forecasts. Trend following makes neither. It reads the current price trend, enters in its direction, and holds until the exit signal fires. The external events that cause or continue the trend are not inputs to any of those decisions.

What makes a complete trend following approach versus a “stock to watch” tip?

A complete approach defines entry criteria, exit criteria, position sizing based on current volatility and account equity, and stop loss placement before any position is opened. A stock to watch provides none of these. Without the complete framework, the watcher does not know when to enter, how much to buy, how to size the position relative to their account, or when to exit. The same stock recommendation can be implemented correctly or catastrophically depending entirely on the system applied to it. The recommendation itself is not the system.

Trend Following Systems
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