Have you thought about the bricks that go into the foundation of trading success?

Anyone who has had a little success investing and chalked it up to luck needs to be wary of falling into the trap of hoping Dame Fortune will look kindly on them a second time. They must consider increasing their odds of winning again by relying on a system instead of luck. Successful investing is neither easy nor obvious. But if you can find a system that gives you the critical edge in the trading process, why not take advantage of it? Luck is not a wise move.

What are some of the crucial components or building blocks of a trading system?

• A system of comprehensive risk management including market exposure weightings, stop-loss provisions and capital commitment guidelines that preserve capital during trend-less or volatile periods.
• A way to limit risk of each position to a predetermined % of equity.
• A strategy for monitoring market volatility and adjusting trading size when risk and volatility exceed predetermined limits.

Richard Dennis provides some valuable words:

Anytime the market goes up a reasonable amount, say a strong day’s work, after you’ve put on a position, it’s probably worth adding to that position. I wouldn’t want to wait for a retracement. That is everyone’s favorite technique — to buy something strong that retraces. I don’t see any justification in the statistics for that. When beans are at $8.00 and go to $9.00, if the choice is to buy them at $9.00 or buy them if they retrace to $8.80, I’d rather buy them at $9.00. They may never retrace to $8.80. Statistics would show that you make more money buying them and not waiting for a retracement.

Neal Weintraub Interview Excerpt

Neal. Would it be fair to describe your trading environment as Spartan? You have no quote monitor and no television.

C.V. I would prefer the term focus. I rarely look at news. Price already reflects what comes out in the news.

Neal. In previous discussions, you talked about the book Market Wizards. Is there one particular chapter you found significant?

C.V. The book was extremely interesting. The chapter on Ed Seykota I found of great interest. Seykota basically says, stick with the trend.

Tom Basso View on Net Wealth

The ability to increase one’s net worth and net wealth [is key]. The net worth of most Americans [for example] is denominated in US dollars, while their net wealth is the purchasing power of those dollars in the global marketplace. An objective for investors must be to increase both net worth and net wealth, which can be accomplished in the currency markets.

This explanation is applicable to all traders worldwide wherever they choose to live.

What These Three Insights Share

Dennis, Weintraub’s interview subject, and Basso are each addressing a component of the foundation that trading success rests on.

Dennis’s retracement statistics argument is the empirical foundation for buy-on-strength entries. The intuitive preference for waiting for a pullback after a strong move feels prudent: you are buying at a lower price. The statistical reality is that many markets that make strong moves do not retrace to the optimal entry point before continuing. The beans that go from $8.00 to $9.00 may never pull back to $8.80. Waiting for the pullback is a form of the price prediction problem: it requires forecasting not just that the trend will continue but that it will retrace first. Buying on strength when the signal fires eliminates that secondary prediction requirement.

The Weintraub interviewee’s “focus rather than Spartan” formulation captures the same insight from the information consumption side. No quote monitor. No television. The news is already in the price by the time it appears on the screen. The practitioner who follows price directly rather than following the news that eventually becomes the price is accessing the information faster and in more condensed form. The environment is not deprivation; it is elimination of noise that would otherwise interfere with the signal.

Basso’s net worth versus net wealth distinction is the global diversification argument stated in purchasing power terms. Net worth denominated in a single currency is not the same thing as purchasing power in a global marketplace. Currency trends that erode the purchasing power of a domestic currency reduce net wealth even as nominal net worth holds steady. Trading systematic approaches in global currency and commodity markets increases net wealth by capturing returns uncorrelated with the domestic currency’s purchasing power dynamics.

Frequently Asked Questions

Why does Dennis prefer buying at the new price rather than waiting for a retracement?

Because the statistics support it. A market that moves strongly from $8.00 to $9.00 has demonstrated directional momentum. Waiting for a pullback to $8.80 introduces a secondary prediction requirement: not just that the trend will continue, but that a pullback to a specific level will occur first. Many trending markets never provide that pullback before continuing higher. Buying at $9.00 when the signal fires captures the trend regardless of whether the retracement occurs.

Why does following price directly outperform following news?

Because price aggregates all participants’ reactions to news, including reactions to news that has not yet been publicly reported, through the trading decisions of informed participants. By the time news appears on a screen or television, its effect on price is already partially or fully incorporated. The trader who follows price is following the market’s aggregate assessment of all available information. The trader who follows news is following a delayed and partial subset of what is already in the price.

What is the difference between net worth and net wealth according to Basso?

Net worth is the nominal value of assets denominated in a domestic currency. Net wealth is the purchasing power of those assets in the global marketplace. When a domestic currency depreciates against global purchasing power, net worth can remain stable while net wealth declines. Trend following in global currency and commodity markets allows investors to capture returns that preserve and increase real purchasing power regardless of what their domestic currency does.

Trend Following Systems
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