TREND
Following—
The Smart Path
to Wealth
By Michael Covel
Trend following is not going to get you
in at the exact bottom or get you out
at the exact top, but it will help you to
capture the meat or middle of any extended and unpredictable trend.
Ignore the fundamentals (“funnymentals”) and parade of gurus ready to provide daily explanations for every market
fluctuation. Follow the price trend of any
market, up or down, for profit. Trend following trading is not difficult, and millions could use its principles now.
more effectively than those who know
fewer of them or know them less well,”
according to Dalio’s firm — Bridgewater.
While Dalio is not a systematic technical trend follower (at least he has not admitted so), his views about principles are
dead on. No principles? You are toast.
BREAK THE CYCLE
People buy into guru predictions about
a market’s direction and tie in fundamental talking points. Later, they invent
a story for why it didn’t work out when
the meltdown finally came. People forget who said what, and the same guru
inevitably begins talking up some other
market within short order.
Ray Dalio runs the world’s largest hedge
fund, and he knows the importance of
principles when it comes to making money.
“Principles are concepts that can be
applied over and over again in similar
circumstances as distinct from narrow
answers to specific questions. Every
game has principles that successful players master to achieve winning results. So
does life. Principles are ways of successfully dealing with the laws of nature or
the laws of life. Those who understand
more of them and understand them well,
know how to interact with the world
CASE STUDY 101
In 2011, there can be no greater poster
child for a lack of investing or trading
principles than seen in the overzealous
proponents of the online DVD rental
service Netflix (NFLX).
The details:
s *ULY HIGH OF s 3EPTEMBER LOW OF If you are a believer in value investing,
fundamentals or averaging down, there
is some rationalization you could have
USED FOR .ETmIX GOING UP FURTHER IN *ULY
Now you might have some rationalization
for why it will go back up. It was easy to
lND ONE OF THOSE *ULY CHEERLEADERS ON THE
.ETmIX SIDE /N *ULY FAMED MARket guru *IM #RAMER offered in an MSN
Money article:
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“To hold on to Netflix or even to buy it,
you have to take a leap of faith about
MANAGEMENT ABOUT #%/ 2EED (ASTings and about his
ability to navigate the
waters of price increases and payments
to creators of entertainment. For me, as
a believer in the stock
SINCE THE S ) HAVE TO TELL YOU THAT
EVERY TIME YOU COUNT (ASTINGS OUT YOU
make a mistake. … The idea that people will leave Netflix in droves because
of an extra couple of dollars seems
fanciful to me. So, yes, I think Netflix is
worth it. I believe that when the smoke
clears on the quarter and we see how
few people actually cancel, we will
once again be amazed at the wisdom of
(ASTINGS AND .ETmIXv
REMEMBER WHEN
Doesn’t Netflix strike eerie similarities to
A DOTCOMERA STOCK *UST LIKE DURING THE
Nasdaq bubble, investors fell in love with
Netflix through nonstop media, news and
alleged great fundamentals. Millions of
Netflix fans valued the service and assumed the stock would only get better.
THE BASICS
You need to answer only five questions
to be a technical trend trader:
1. What market do you buy or sell at
any time?
(OW MUCH OF A MARKET WILL YOU BUY
or sell at any time?
7HEN WILL YOU BUY OR SELL A MARKET
7HEN DO YOU GET OUT OF A LOSING POSItion?
7HEN DO YOU GET OUT OF A WINNING
position?
TREND IN ACTION
(OW WOULD THAT HAVE PLAYED OUT WITH
Netflix? You ride it up as high as it goes.
When it starts going the other direction,
you get out or go short.
(OWEVER THE TOUGH PART OF TREND FOLlowing is in the mental side of the equa-
OPTIONS
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tion. Following those five simple rules is
not easy when nearly every aspect of the
public investing universe presents opposing messages.
For example, noted economist Robert Shiller recently lamented that the
“extraordinary surge of stock market
volatility during the last month can’t be
explained by conventional means. Yes,
hundreds of scholarly papers have tried
to predict the size of such swings, and
whole markets like those for futures and
options thrive on these movements. Yet
we still don’t have a clear, mathematical
understanding of volatility’s source.”
IT DOESN’T MATTER
Trend followers have proven (with performance on file with the federal government) that you don’t need to think like
Shiller to make money. The only pertinent factor when it comes to Shiller’s
analysis: You will never understand the
source of volatility in any useful way.
Knowing the source will not make money, and it is a waste of time.
SMART PATH TO WEALTH
Trend following is a strategy built on
self. It is a strategy predicated on rigid
and unemotional rules. Adopting some
principles will make sure you are not
left holding the next Netflix bag.
There is a substantial risk of loss in trading commodity
futures, options and off-exchange foreign currency products.
Past performance is not indicative of future results.
Michael Covel is the author of “Trend Commandments”
(FT Press) and “The Little Book of Trading” (Wiley).