Trend - مكتبة خبراء المال

fpref.qxd 9/13/06 8:58 AM Page xiiiPrefacexiiiMy studies to improve this area of my trading led me to the methodsof the master trend following traders in the futures markets, some ofwhich were recently popularized by Michael Covel in his excellent bookTrend Following2 and on his Web site www.turtletrader.com. I became attracted to trend following trading methods because I admired how objective and disciplined their practitioners in the futures markets are abouttrading their ideas. I also found parallels between their position management philosophies and those of equity traders such as the great Jesse Livermore, immortalized in Edwin Lefevre’s Reminiscences of a StockOperator,3 who I refer to many times in this book. Many of these large futures money managers trade the markets in a completely systematic manner, often buying rising financial instruments and selling or shortingfalling ones. My studies into the level of rigorousness these traders applied to their work4 inspired me to improve my own trading by mimickingcertain aspects of their methods. I detail in this book how I view thesemethods and how I have adapted some of them for my personal use in equity trading.I find the methods of these systematic traders most useful for theirrigorous application of exit timing and position sizing techniques, and it isthese areas that I have adapted the most to my own trading. I also usetechnical indicators to define market trends in an objective manner, whichcan provide a filter for putting on or exiting certain types of trades. I donot have anywhere near the research and back testing capabilities of themajor funds but have found their trade planning discipline worth emulating. I make investment decisions based on personal insights gained fromobserving market conditions and reading a wide variety of material, ratherthan after rigorous back testing, which makes my approach to researchdifferent from that of a purely systematic trader. However, I then executeon some of my insights by planning my trade executions in a manner similar to a systematic trend follower. I have found this hybrid of unsystematicresearch and well planned trade execution suitable for me.The major futures trend followers, on the other hand, use extensiveand very sophisticated back testing software to analyze the profitabilityof their insights. They are also generally diversified across multiple assetclasses besides equities. A full application of their back testing and diversification methods is beyond my scope and likely to be beyond the scopeof many individual equity investors as well. However, I have adaptedwhat I find useful in their methods to my own trading, and am certainthat other traders and investors can benefit by doing the same. In thisbook I refer to traders and investors interchangeably, as there is no wayto invest without trading.An equity investor might mistakenly think that since some futurestrend followers have been so successful that they can just apply the same

fpref.qxd 9/13/06 8:58 AM Page xivxivPREFACEtrend following methods to an individual asset class, like equities, and retire rich. This is of course not the case, and I have also written this bookto provide the reader with information that I have found important toknow in my trading of equity trends specifically. The process of planning atrend following trade or structuring a portfolio in equities is not trivial.There are also vast differences between applying trend following techniques in a futures portfolio versus an equity portfolio, such as the highlevel of correlation between equity instruments. I explain in this book mytake on these issues.Planning my trades in detail is one of the most important disciplines that I have developed in my many years of trading. Let me walkyou through a scenario to show you why. Imagine that you decide tobuy 1,000 shares of a stock after doing your own due diligence. All of asudden, a talking head comes on financial television and before you cantake a deep breath, the stock has plummeted 1. Do you cut your position? Buy more? Did you plan for this contingency when you decidedhow much to buy, or have you bet the farm? Does the broader marketgive you any clues about the state of sentiment out there? What if thestock that you bought goes on to rally 2 after falling 1? Most peoplewould be content to flatten out for a profit and call it quits. But what ifthe stock is about to move 5 higher? Are there any rules you can use toparticipate in some of this upside? How do you press your winnerswhile keeping your losses limited? Each trader must answer questionslike these over and over again while trading. This book helps you to define your answers to all of these questions in a logical, simple, and relatively quick manner before you enter the market, allowing you to spendmore time finding great investing ideas and to streamline your tradeplanning process.Trend following in which you chase prices on both your entry and exitis often a very volatile strategy and cannot be blindly applied to equities,especially since so many equities tend to move in unison. I thus use thiskind of trend following very selectively, and only with risk capital. Since Ihave found the trade planning process of trend followers very useful,however, I use similar methods to help me manage my open position profits and losses on individual trading ideas. Trend followers in the futuresmarkets follow price trends in a variety of asset classes after rigorousback testing, which I lack the resources to do in equities. However, I havefound that what I can do as an equity trader is to plan my trades in detailbefore I enter them, allowing me to cut my losses short and let my winners run without emotion. In short, if there is a trend in my favor in myopen position profit and loss (P&L), I want to follow it to its full potential.In order to do this properly, I have to define the conditions that constituteits full potential in advance.

fpref.qxd 9/13/06 8:58 AM Page xvPrefacexvI thus believe that you can still be a trend follower if you exit the market with trend following techniques even though you may enter it by buying a dip instead of a rally. You can be a trend follower if you go long asideways moving stock during a period that you perceive as a broadermarket uptrend. You can be a trend follower if you resemble a buy andholder during a period that you perceive to be a decade long bull market(as long as your positions are profitable on paper). In short, whether youare a trend follower is determined by how you react to your open profitsand losses once you have entered the market, rather than by whether youuse the completely systematic research, testing, and trading strategies ofthe trend following market wizards. I thus write this book to show you indetail how to rigorously plan your trades in the spirit of these mastertraders, and also to suggest new areas in the equity markets to apply technical analysis to aid you in your search for an edge.The main questions this book answers are:What are the major differences between trading trends in the equitymarkets versus the futures markets?How do you plan an equity trade using trend following techniques?How can you structure an equity portfolio to trade ideas with trendfollowing or technical trading techniques?How might you use trend following techniques to rotate from an investment in one instrument to another?WHY THIS BOOK IS IMPORTANTMany investors sustained tragic losses in the bear market years from 2000through 2002. I can imagine that it was especially tough for those whoheld falling mutual funds whose strategies they did not fully understand,or held falling stocks they had bought with no plan of action. This bookgives you some easy to apply ideas about how to take more control overthe investment process and better estimate your risks when trading. Inthis way whether you win or lose in the markets, you will at least have anidea of what you are getting yourself into.In my market readings, I noticed a lack of material that discusses trading equity trends on the very detailed level of position sizing and otherrisks. As a result, I have written this book to appeal to a wide range of investors, and so its scope runs from the simple to the more complex. Manymarket participants trade on every urge, using undisciplined money management and rapidly switching strategies without giving them a chance to

fpref.qxd 9/13/06 8:58 AM Page xvixviPREFACEwork. These traders panic out of winning positions and stubbornly hangonto losing ones, without a proper understanding of the risks they are exposing themselves to. As a trader, you need to know how to plan specifictrades well enough that you could leave your instructions with someoneelse to trade them and be comfortable that every contingency would becovered. I want to convey some of my ideas about how to do this to thereader. If you have the patience to follow my reasoning through thesepages, I am confident that you will find this book an excellent investmentof your time. To know that I have been able to help even one investor approach the markets more intelligently would make the writing of thisbook entirely worthwhile to me.KEDRICK F. BROWNEast Brunswick, New JerseyJanuary 2006

flast.qxd 9/13/06 8:59 AM Page xviiAcknowledgmentsIwould like to extend special thanks to several wonderful and generouspeople who helped to make this book possible. To my wife Ivana—Icould not have completed this book without your love, patience, amazing editing help, and unwavering support. Thank you from the bottom ofmy heart. To Stephen Engst—Your frank advice and help on this work hasbeen invaluable. Thanks for being a true friend, and for sharing your wisdom about trading, trend following, and life so generously. To my brotherBaika, a true genius with computers—Your help has made a big difference. To my editors Pamela van Giessen and Jennifer MacDonald—Thankyou for giving me this chance, and for your wonderful support along theway. To Dave Goodboy—Without your encouragement, my writings mightstill be only on my computer. Thank you. To my attorney Kevin Pollock—Thanks for all you have done to make this possible. To my cousin Annis—Thanks for introducing me to the world of equity trading. There are alsomany others to whom I am grateful for having reached this point in mylife, from family to teachers to colleagues to friends. Thank you all sovery much.K.F.B.xvii

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ccc brown 003-030 ch01.qxd7/27/061:31 PMPage 3CHAPTER 1Elementsof an EdgeTHE EFFICIENT MARKET HYPOTHESISThe efficient market hypothesis contends that “the rewards obtainable frominvesting in highly competitive markets will be fair, on the average, for therisks involved.”1 This definition says that it is very difficult to consistentlyachieve abnormally large returns in exchange for taking normal risks. Thetremendous amount of competition from investors of all types struggling todo this in the stock market helps to push the market toward efficiency. Theefficient market hypothesis doesn’t mean you should give up trying to outperform the market, but it is good to be aware that it is not a cakewalk. Aprimary tool to be equipped with in this quest for superior performance,which many traders lack, is the discipline to plan your trades properly.Investors are not always well compensated for the risks they take on.If you had shorted the Standard & Poor’s (S&P 500) at any time prior to1997 and had held to the present (early 2006) you would have lost a greatdeal of money. Taking on risk does not always mean that you will be compensated for it, because then it wouldn’t be real risk. No matter what hashappened in U.S. stock market history, we may one day find ourselves inan extended bear market such as Japanese equities during much of the1990s. I for one would not be able to hold the bulk of my money in a fallingmutual fund through an extended multiyear period, regardless of what theefficient market hypothesis implies about how difficult it is to outperformthe market. What if I suddenly need the money when my capital is down50 percent from its peak? I might have faith that the fund would reboundbut would have to exit because of necessity. It would be unbearable not to3

ccc brown 003-030 ch01.qxd7/27/0641:31 PMPage 4TREND TRADING PSYCHOLOGYknow how the portfolio manager was allocating and managing my money.When I invest or trade, I prefer to know what I am getting myself into sothat I can sleep at night. This requires me to believe in my reasons for investing and use reasonably objective estimates of the downside risk I amtaking on in my trades. Technical analysis is a powerful ally in accomplishing this goal.Any rational trader would want limited downside exposure and thechance to capture open-ended profits if a position moves in their favor.However, few take the time to plan out exactly how they will trade individual situations. Technical trading forces you to think in exact terms andobjectively plan your trades. If you are skilled at identifying outstandingprofit opportunities, timing your trades with technical methods can enable you to perform very well in the markets.PLACING TECHNICAL ANALYSIS IN ITSPROPER CONTEXTCountless books have been written about stock charting. In addition totrend lines, which are well-known, there are a host of technical indicatorsthat are widely used in attempts to predict the future although their effectiveness in doing this is often questioned. Although traders often try to usetechnical analysis as a crystal ball, this is by no means its only use. Amuch more important use of it is to objectively size and time investmentsin potentially profitable situations. Thus, technical trading is worth understanding because it can be used to trade unfamiliar market situations—volatile tech stocks, sudden breakouts in previously quiet industries, andso on. However, since technical analysis is so often used in attempts topredict the future, it pays to briefly discuss some of the pitfalls that canarise from using it in this manner.Trend Line IssuesEven in a price signal that moves up and down unpredictably, or “randomly walks,” chart patterns such as double bottoms are often present.Since people see pictures in clouds, we should naturally expect that theywill see stock prices bounded by imaginary lines and curves on stockcharts. Randomly walking data can easily be used to create trend lines,moving averages, moving average convergence/divergence (MACD) oscillators, and a host of other indicators that are usually derived from historical prices. This is a fact that needs illustrating. Figures 1.1 and 1.2 showrandomly walking charts generated using two different methods.

ccc brown 003-030 ch01.qxd7/27/061:32 PMPage 5Elements of an EdgeFIGURE 1.1 A random walk with equal step size.FIGURE 1.2 A random walk with variable step size.5

ccc brown 003-030 ch01.qxd7/27/0661:32 PMPage 6TREND TRADING PSYCHOLOGYFigure 1.1 shows a randomly walking pseudo-price series that hasbeen generated using steps of equal size (0.5 in this case). Even in thisvery simple chart, there is a very obvious trend line. A commentator mightdescribe the action by saying, “As soon as price broke through the supportprovided by the long-term trend line, support became resistance. Resistance was then briefly tested but the valiant attempt failed and pricesrapidly moved lower.”Figure 1.2 shows a randomly walking series generated using steps ofvariable sizes between 1.0 and –1.0, rounded to the nearest 0.1. Thischart looks a little more like a standard stock chart, which also has day-today movements of varying sizes. I’ve also drawn a trend line on this chartwith little effort. In this case a commentator might describe the action bysaying, “As soon as prices broke up through the downward trend line,they rapidly moved higher.”Now let’s look at a third chart of real stock prices, in this case IntelCorporation (symbol: INTC) in 2002 through 2003, which is shown in Figure 1.3. Once again, I’ve drawn a trend line on this chart, but you must beasking by now, “Why would trend lines have predictive power on a realstock chart if they lack predictive power on a randomly walking simulatedstock chart?” This is a great question. Since there is such a strong visualsimilarity between real and random prices, and since the effectiveness ofFIGURE 1.3 A real stock chart—Intel Corporation, 2002–2003. (Source: Stockprice data from Yahoo! Finance.)

ccc brown 003-030 ch01.qxd7/27/06Elements of an Edge1:32 PMPage 77technical trading methods to predict the future is so fiercely debated: Iprefer to approach each stock that I invest in as if its short-term pricemovement will be completely unpredictable once I am in the stock.This approach forces me to look at factors other than the stock’s pricealone for relationships or ideas that support my decision to invest in it. Inother words, it is much easier for me to buy a stock if I believe there is anunderlying theme that will cause the stock to drift upward over the intermediate to long term, as opposed to only looking for profitable patterns inpast price data.William Gallacher expounds on the weaknesses of using trend linesfor real world trading in his book Winner Take All. Trend lines, although very famous as technical indicators, are often obvious only inhindsight.2 Two short-term peaks occur in a descending stock, so atrend line is drawn that connects them, with the obvious implicationthat if price breaks above the trend line, a “breakout” has occurred thatshould be bought. If the breakout succeeds, it “confirms” that trendlines work. However if the breakout immediately fails, the small breachof the trend line is often overlooked—maybe “price failed to break decisively through resistance.” If price does break decisively through resistance and then makes a new peak, a new trend line is drawn betweenone of the old peaks and the new peak, and the process starts all overagain. To each his own, I suppose, but this is too much ambiguity for meto trade with.Many traders use trend lines to see what they want to see, or to justifyholding existing positions after they are already in. As a general rule, Idraw only basic conclusions from my examination of individual stockcharts, because the future can change dramatically and unexpectedly. Ofcourse, I take note if a stock’s chart appears very bullish (sustained upward movement, perhaps accompanied by unusually strong volume) orvery bearish. I have found that it can be dangerous, however, to draw conclusions about whether a stock is too “high” or too “low” based on how achart presents the data. High stocks can always move higher and lowstocks can always move lower. Whether I buy at what appears to be a highprice or what appears to be a low price is based entirely on the contextprovided by factors other than the stock’s price. These factors are continually subject to change but may include the price action of the overallmarket or the stock’s industry, articles that I have read or anecdotes that Ihave observed, and fundamental data about the company.Chart Scale IssuesMost computer charts today tend to take price data within a certain timeframe and automatically scale the data around the limits of the price

ccc brown 003-030 ch01.qxd87/27/061:32 PMPage 8TREND TRADING PSYCHOLOGYmovement. This means that if a stock moved between 17.52 and 24.60over the period of a chart, it might be scaled so that the lowest price onthe scale is 17 and the highest price is 25. Thus, if the stock happened tobe trading at 24, you would see its price as “high” on the scale you are using. If the stock happened to be trading at 18, you would see its price as“low” on the scale. Of course “high” and “low” are all relative; if the stockproceeds to move rapidly up to 48.42, so that its range over a similar period is now bet

of the master trend following traders in the futures markets, some of which were recently popularized by Michael Covel in his excellent book Trend Following2 and on his Web site www.turtletrader.com. I became at-tracted to trend following trading methods because I admired how objec-