Evolve Or Die
Trend following systems only work some of the time. They only work when there are huge sustained trends that occur in the markets. Those types of trends eventually reverse or there are many years where the markets can stay in a range for a long time. Trend following systems get destroyed in such market environments.
The people from Commodities Corporation were very fond of charts. All the traders you hear about from the past including Michael Marcus, Bruce Kovner, Paul Tudor Jones. A lot of them were skilled chartists. And you know what, the chartists made money back in the late 1970’s when there were huge trends in the commodity markets. All you had to do was buy a breakout and it would run for an insanely large amount. Your reward risk ratio would be terrific as the trends just kept on going and going.
Any fool can make money in those huge trends. All they have to do is follow the trend, have a simple system for buying the breakouts or the retracements. They place their stop at a decent level. But the momentum of the trend would save them and cause their trades to turn into profit. Then they just keep pyramiding all the way up.
Richard Dennis said of the period in the 1970’s:
Anyone with a simple trend-following method and a dart board could make a million dollars.
Pure chartists that like to trade based on breakouts used to make a lot of money back in the late 1970’s where there were a lot fewer false breakouts in the markets. The market would post a chart pattern, breakout and run for a large amount. Since there has been a proliferation of chartists, their trading returns have decreased. The number of false breakouts have increased. Traders stops are getting hunted more and more often.
Which is where order flow trading comes in. Armed with knowledge about order flow, information flow, liquidity, global macro, etc, you can become the most profitable type of trader that makes money in all types of market conditions.
Order flow traders, especially those with knowledge of news, sentiment and global macro know how to look at the at the charts, but more importantly they know what to analyze outside of the charts.
There is always a reason for the charts to making huge trends and easy breakouts. The huge inflationary environment in the 1970’s made it ideal for the chartists to make money. But the markets do not stay in trends forever.
Which is why you need to realize when the markets are going to be stuck in a choppy range and face the prospects of many false breakouts. So you can know when the reward risk ratio is unattractive to trade in the direction of the breakout. So you know when to stay out of the choppy markets and go find a market that has a better global macro environment for a huge breakout or volatility explosion. So you know when the chances for the market to make a false breakout is very high and you can implement order flow strategies to take advantage of that time period. Strategies such as stop hunting, option barriers, sentiment/fundamental value shifts for one day.
You do not have to force yourself to range trade markets. You can always just go look for a different market that is trending, or going to be trending. There are plenty of newbies and chartists making a fortune playing the gold trends. All they have to do is wait for the breakout and buy. All they have to do is wait for a consolidation and buy the breakout. All they have to do is wait for some sort of pullback to enter. The market runs up for a few days or a week or two and take your profit. Rinse, repeat.
Any fool can make money in such environments. And you should milk them for all they are worth. Always prefer the easy money to the difficult money.
But eventually all trends come to an end and the inevitable reversals come. And that is when the pro traders who can manage risks and sense the coming sentiment/fundamental value shift take huge amounts of money from the amateurs.
Richard Dennis, the famous trend follower, suffered crippling double digit losses during 1987. Meanwhile, Paul Tudor Jones caught the market crash and posted a huge triple digit return year.
Why was one person able to make a killing, while someone else suffered huge losses? Perhaps one of them knew far better how to identify the turning points, the shifts in sentiment and fundamental value?