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The method: Trend following or not? Part 1 - by Mark Brown

Trend following strategies try to take advantage of long-term moves that seem to provide an edge in various markets. Trend following is a term used to describe those who trend trade. Trend followers are always looking and waiting to identify a trend then follow it. Trend followers enter the market after the trend has been well established and for that reason they miss the initial turning point. In order to compensate for the market movement which was not initially captured. Trend followers must now hope that the current move will be of great enough magnitude to profit from.

The trend is your friend or so they say. Most often traders will tend to focus in hindsight upon a large trend movement. However trends can only be seen in hindsight. It is impossible to determine the trend prior to the beginning of the trend. So what can you do to capitalize on the large profits that trends produce? You can prepare and study non-trending action; completely master identifying non-trending action and what you are left with can be nothing other than the trend correct? We will certainly explore into this theory and uncover other discoveries that may indeed surprise even the most ardent of trend followers. 

When determining exactly what non-trending market action is, there can be a lot of confusion. It is exactly like trying to find your way without a road map or a GPS system. It can be confusing and an extremely daunting task unless you have some perceptions. This initial experience that is required can only be obtained through lots of hard work and determination. All data is not created in equal, we will explore further into the subject later in this series of articles. It is often claimed by both counter trend and trend followers that the current price itself will tell you what the market is doing. 

Typically the trend system development pursuit of perfection ejects external influences that would typically be considered. The more focused the development process to improve the train of thought. The less likely chance of implementing ideas outside the typical realm of known tactics will exist. Prudence would dictate that there are improvements available for those developers who will at least consider that improvements and solutions could possibly exist. Surely the pursuit of capital gain will influence this battle and some common ground can be obtained.

The complexity of the subject matter that is about to follow is such that we will need to break apart into many sections, all the pertinent details. However complex this process may appear, it is really very necessary to gain a thorough understanding so that simplified trading mythology can emerge. Often times it is necessary to delve into every aspect of particular method to extract some small edge.  One particular edge by itself may not prove independently profitable but when combined with other discoveries a profitable method may be constructed.

With utmost certainty tradition trend following methods can be described as being primitive at best. Little advancement has been made in the area of technical analysis let alone trend following methods themselves. We will begin an exploration into data manipulation that could be used to assist in finding the highest percentage of replicable patterns possible. The pursuit here is knowledge, confidence and dependability. There will be several exercises revealed during this process none of which should be taken in whole or part as an absolute. 

It is obvious to see that trend following is not unto itself a perfect method of trading this chart clearly shows how confused a trend model can get when faced with a non-trending sideways market. It mindlessly continues to buy when it should be selling and sell when it should be buying. Most if not all profits gained during the big trending period has been eradicated completely.  Read more >

The data: What’s wrong with my data? Part 2 - by Mark Brown

Data is often taken for granted by system developers. It’s probably thought about less than any other single item in the modeling environment. Yet data is the foundation of any successful trading methodology. In fact, data if processed correctly could quite possibly prove to be a stand-alone trading system. Caution should be taken to prevent a lack of diversity when testing systems. Yet a paradox exists because in order to gain confidence in a method some curve fitting should be explored. There are positives and negatives to be learned from the process. Over optimization should be avoided in the final draft of any system.

The desire to produce profitable results can cause one to become blindsided when going through an optimization process. For this reason it is important to properly mate a system method to a particular data type. An example would be to group Debt instrument data in a testing series and Index data in another. Often systems will be compatible within an industry group as well. For example a system may work well on Airline Index stocks yet not work as well on Banking Index stocks. Data has personality and it is imperative to exhaust every effort to extract every detail. 

It would be important to mention the merits of modeling that have the capabilities of performing profitably over a vast range of market products. Testing will most likely revel however that great difficulty will arise in obtaining the levels of profitability, which can be achieved with so called one market systems. Nonetheless it’s a great confidence booster to have a model that will perform well in a multiple market environment. 

Once found using this base a modeler could fine tune and build a market specific system from this core. This entire process is necessary to reinforce a confidence level that can be only achieved though gained experienced. There is no substitute for actually going through the process in order to completely absorb the results and understand the benefits of the mechanical analysis process. 

Data should be recognized as a minimum of two parts. One of which is trending data and the other non-trending data often times confused with noise. Yes there are many aspects of data however the two identities mentioned above are the mainstay of any profitable model. These parts will yield the most consistent profitability that can be depended upon being successful to replicate. 

Noise can also be traded however it is not as dependable to find patterns when using higher time frames such as daily data. Using Visual Recurring Analysis software a model builder can identify hidden patterns within the data. VAR can also be used to great success to identify patterns in trading results data and capitalize upon little known techniques.  

Each part of a data series, the trending and non-trending portions should be compiled into separate series and analyzed for traits. These inherent traits once discovered will awaken an entire new world of possibilities. Data will never look the same and the inner hidden qualities of it will make one wonder why it was never seen before. Armed with this insight it will be possible to explore new techniques that would have never been thought possible let alone practical to implement.  Application of advanced concepts is futile unless it is understood why it would be a good fit and best-case scenario. Again, there is no substitute for experience.  Read more >

The mind: Is it possible to accept success? Part 3 - by Mark Brown

Often profitable methods are accidentally stumbled upon and yet they are unnoticed most likely because they did not resemble the expected outcome. As if it were not difficult enough to develop a dependable trading method and then become familiar with it as to have unwavering confidence to implement such. Caution must be exercised to circumvent the possibility that the human element when involved does not taint the discovery process. This is where it is best to let the numbers guide the way to a consistent replicable method rather than visual opinions. Constant balancing of variables are needed and a tolerance to looseness of fit will expedite acceptable results.

There are many mental deterrents to success. One such obstacle is often described as analysis paralysis. This can truly hinder a trader permanently, rendering a person incapable of making a decision or implementing a plan. Other conditions such as information overload can lead to bewilderment feelings and emotional ups and downs. Often it’s overlooked that a method can be found though not perfect and implemented to serve a goal that can be accomplished. Experience dictates that only resting phases exist when a model will go through an enjoyable unattended period of profitability. Constant adjustments to a model must be kept to an absolute minimum once implemented. There exist a benchmark for knowing when a method no longer works. Sometimes even a failed system will give up some profits prior to abandonment. Timing is critical this will be discussed later in the series.  Read more >

The mix: Two methods better than one? Part 4 - by Mark Brown

Typical trend followers must always follow the price action when it leads in a direction else they would miss a move. Most moves are false and leave the trend trader with a loosing trade. Analyzing these trades one would notice that had the position simply been reversed the trade would have most likely gained back the lose that it just endured. Any apprehension in performing this reversal trade is caused simply from a lack of understanding and knowledge that indeed it does work. Commitment is needed to become a trend follower. Likewise it takes commitment to be a counter trend trader and fade a move as it is accelerating in the opposite direction of your order.

Counter trend trading dictates that one be committed to the markets always in. That is to be in a position long or short all the time. Invariably one will miss a move that would have been profitable had the system been in the market. The weakness of counter trend trading is that once in a while a move will become highly volatile against the current position. The system will have to take a loss and reverse or suffer a draw down and hopefully recover with subsequent winners. Typically counter trend systems win a higher percentage of trades with smaller profits per trade and an occasional large looser. While trend system on the other had typically endure a multitude of small winners while waiting for a signal large winner that will hopefully finance losses and leave a profit.

Two conflicting methods, one common goal. To capitalize off market action and make a profit within a reasonable risk. It is very possible for a determined modeler to combine each of these methods into one unified system working in harmony. First each method must be exhaustively tested on its best and worst market conditions. This will reveal the strengths and weaknesses of each method. Then starting with the counter trend model first. VAR and statistics from the individual trades should be used to understand where the hidden optimal reversal pattern exists. These patterns and parameters once found facilitate the blending in of the trend method.  Read more >

The reality: Where theory gets put to the test! Part 5 - by Mark Brown

Theory is cheap and everybody has one. What separates a well thought out application from a dismal doomed failure is more often than not time. Time is the element, which will not guarantee success. However success in development cannot be gained without ample amounts of time spent enduring trial and error. Time and time again non-experienced traders hit upon a method which seems promising on limited points of data yet falls apart as time passes on. Often traders cannot hope to overcome the inability to distinguish a discovered edge from a random event. It is an eye-opening event when one discovers that a world exists that affects the outcome and you have just now discovered it. Perhaps you may have been better off not knowing and leave it to random events to dictate the outcome.  Read more >

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