The Realities of Trend Following

Learn How to Trend Follow Andrew Abraham TrendFollowingMentor.com

Contact me with your thoughts or questions Andrew@TrendFollowingMentor.com

Risk Disclaimer

THE RISK OF LOSS IN TRADING COMMODITIES CAN BE SUBSTANTIAL. YOU SHOULD THEREFORE CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR FINANCIAL CONDITION. IN CONSIDERING WHETHER TO TRADE OR TO AUTHORIZE SOMEONE ELSE TO TRADE FOR YOU, YOU SHOULD BE AWARE OF THE FOLLOWING: IF YOU PURCHASE A COMMODITY OPTION YOU MAY SUSTAIN A TOTAL LOSS OF THE PREMIUM AND OF ALL TRANSACTION COSTS. IF YOU PURCHASE OR SELL A COMMODITY FUTURE OR SELL A COMMODITY OPTION YOU MAY SUSTAIN A TOTAL LOSS OF THE INITIAL MARGIN FUNDS AND ANY ADDITIONAL FUNDS THAT YOU DEPOSIT WITH YOUR BROKER TO ESTABLISH OR MAINTAIN YOUR POSITION. IF THE MARKET MOVES AGAINST YOUR POSITION, YOU MAY BE CALLED UPON BY YOUR BROKER TO DEPOSIT A SUBSTANTIAL AMOUNT OF ADDITIONAL MARGIN FUNDS, ON SHORT NOTICE, IN ORDER TO MAINTAIN YOUR POSITION. IF YOU DO NOT PROVIDE THE REQUIRED FUNDS WITHIN THE PRESCRIBED TIME, YOUR POSITION MAY BE LIQUIDATED AT A LOSS, AND YOU WILL BE LIABLE FOR ANY RESULTING DEFICIT IN YOUR ACCOUNT. UNDER CERTAIN MARKET CONDITIONS, YOU MAY FIND IT DIFFICULT OR IMPOSSIBLE TO LIQUIDATE A POSITION. THIS CAN OCCUR, FOR EXAMPLE, WHEN THE MARKET MAKES A LIMIT MOVE. THE PLACEMENT OF CONTINGENT ORDERS BY YOU OR YOUR TRADING ADVISOR, SUCH AS A STOP LOSS OR STOP LIMIT ORDER, WILL NOT NECESSARILY LIMIT YOUR LOSSES TO THE INTENDED AMOUNTS, SINCE MARKET CONDITIONS MAY MAKE IT IMPOSSIBLE TO EXECUTE SUCH ORDERS. A SPREAD POSITION MAY NOT BE LESS RISKY THAN A SIMPLE LONG OR SHORT POSITION. THE HIGH DEGREE OF LEVERAGE THAT IS OFTEN OBTAINABLE IN COMMODITY TRADING CAN WORK AGAINST YOU AS WELL AS FOR YOU. THE USE OF LEVERAGE CAN LEAD TO LARGE LOSSES AS WELL AS GAINS. IN SOME CASES, MANAGED COMMODITY ACCOUNTS ARE SUBJECT TO SUBSTANTIAL CHARGES FOR MANAGEMENT AND ADVISORY FEES. IT MAY BE NECESSARY FOR THOSE ACCOUNTS THAT ARE SUBJECT TO THESE CHARGES TO MAKE SUBSTANTIAL TRADING PROFITS TO AVOID DEPLETION OR EXHAUSTION OF THEIR ASSETS. THIS BRIEF STATEMENT CANNOT DISCLOSE ALL THE RISKS AND OTHER SIGNIFICANT ASPECTS OF THE COMMODITY MARKETS. YOU SHOULD ALSO BE AWARE THAT THIS COMMODITY TRADING ADVISOR MAY ENGAGE IN TRADING FOREIGN FUTURES OR OPTIONS CONTRACTS. TRANSACTIONS ON MARKETS LOCATED OUTSIDE THE UNITED STATES, INCLUDING MARKETS FORMALLY LINKED TO A UNITED STATES MARKET MAY BE SUBJECT TO REGULATIONS WHICH OFFER DIFFERENT OR DIMINISHED PROTECTION. FURTHER, UNITED STATES REGULATORY AUTHORITIES MAY BE UNABLE TO COMPEL THE ENFORCEMENT OF THE RULES OF REGULATORY AUTHORITIES OR MARKETS IN NON-UNITED STATES JURISDICTIONS WHERE

YOUR TRANSACTIONS MAY BE EFFECTED. BEFORE YOU TRADE YOU SHOULD INQUIRE ABOUT ANY RULES RELEVANT TO YOUR PARTICULAR CONTEMPLATED TRANSACTIONS AND ASK THE FIRM WITH WHICH YOU INTEND TO TRADE FOR DETAILS ABOUT THE TYPES OF REDRESS AVAILABLE IN BOTH YOUR LOCAL AND OTHER RELEVANT JURISDICTIONS. THIS COMMODITY TRADING ADVISOR IS PROHIBITED BY LAW FROM ACCEPTING FUNDS IN THE TRADING ADVISORS NAME FROM A CLIENT FOR TRADING COMMODITY INTERESTS. YOU MUST PLACE ALL FUNDS FOR TRADING IN THESE TRADING PROGRAMS DIRECTLY WITH A FUTURES COMMISSION MERCHANT.
HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS ** THE MATERIAL DISPLAYED ON THIS WEBSITE IS INTENDED FOR EDUCATIONAL PURPOSES ONLY

Trading futures and options involves substantial risk of loss no matter who is managing your money and is not suitable for all investors.
Past performance is not necessarily indicative of future results.

TOPICS COVERED
Introduction.. Compound Your Way to Wealth.... Your Curve is the Key.. The Mathematics of Compounding.. Curves, Curves, and More Curves What It Takes to Succeed KISS (Keep it Simple Stupid)... 4 Possibility Thinking Why Commodities?.................................................................................. What You Should Focus On. Its Simple, But it Aint Easy. Blueprint for Success

Its what you learn after you know it all that counts -John Wooden

Introduction
Albert Einstein called the power of compounding the greatest mathematical discovery of all time and deemed it to be the eighth wonder of the world. Richard Russell of the famed Dow Theory Letters declared that compounding is the royal road to riches. I agree with both of them.

Combining realistic annual returns with the power of compounding is a powerful recipe for building wealth.

Here is the formula: (Realistic Returns + Compounding) =Wealth Unfortunately, most investors are unable to consistently achieve the investment returns necessary to compound their accounts. The problem is that most investors do not understand how to formulate a plan that will accomplish this. The purpose of this guide is to provide a solution to that problem. My solution is called Trend Following. Richard Donchian is considered by many to be the father of trend following. Donchian was an investor during the Great Depression and he lost everything while investing in the Stock Market during this period. However by the 1940s he learned from his mistakes and started the concept of trend following. He would buy breakouts and look to stay with a trade as long as it was moving in

the direction he placed his trade. Donchian continued trend following for almost 53 years thereafter. Donchians trend following strategy worked in the past and will likely continue to be successful in the future. There are many commodity trading advisers who have been trend following & compounding money over time for decades such as Campbell & Company, Abraham Trading Group, Clarke Capital, Tactical, Chesapeake and many others. Do not think that Trend following is retirement in a box. There will always be periods of losing money and periods that are not profitable. As much as trend following gives you the possibility to compound money and build wealth over time there are substantial risks with trend following and one must determine if this is a strategy is appropriate for them. Trend following and commodity trading is not suitable for all investors. There have to be other solutions for ways to compound money over time and I am not claiming that trend following is the only solution to compound money over time, but I do know that it has benefited me personally over many years. I remain confident that trend following will continue to work well, regardless of the market conditions. While there are no guarantees where the future is concerned, I do believe that trend following puts the odds of success in the investors favor. Investors need to take into account that trend following takes time. Trend following is not a get rich quick scheme. It is similar to a marathon. Marathons are grueling and hard. When someone commits to the strategy there are no short cuts. There will always be drawdowns and long periods that profits are elusive. More so there will be periods that are just plain ugly and trading accounts diminish in value.

Trying to build wealth is a serious challenge. People do not know if they should be invested in stocks, bonds, real estate, gold, commodities, or any of the other alternative investment vehicles available today. As the financial markets are perpetually in motion, this is an ongoing problem.

My solution to this problem starts by understanding the following:

Compounding money is the key to building wealth Creating an upward sloping equity curve will enable one to compound their money. An equity curve is simply a picture or graph showing you how much money you are making or losing. Trading with the trend, cutting losses, and letting your profits run is the method I use to build an upward sloping equity curve.

The benefits of my solution and what it means for you:

Your equity curve will be upward sloping and you will be compounding your account at reasonable rates of return - YOU WILL BE BUILDING WEALTH! You will have a plan and you will know what you are supposed to be doing (or even more important what not to be doing.) You will be invested in areas that offer profitable opportunities because they are trending. You will avoid large losses by being on the wrong side of major trends for example: dot.com bubble in 2000, real estate in 2006, stocks in 2008, etc.

 You will be prepared for those periods where few trends exist and we suffer losses. (better to be prepared than surprised)

Someone once asked if you dont know where you are going, how are you going to get there? Therefore the first step in acquiring wealth is to understand what we are trying to accomplish. We were all taught in school about the magic of compounding. However, as I already stated, the great majority of investors are unable to formulate a plan to enable their investments to compound.

My goal in writing this guide is twofold: 1. Explain WHAT we want to do. (Compound our way to wealth by building an upward sloping equity curve) 2. Teach you HOW to do it.

The most successful trend followers have the following in common:

1. They understand the power of compounding and their goal is to compound their accounts over time 2. They are NOT big risk takers and are actually more risk averse than one might suspect 3. They have a detailed plan of exactly what they are supposed to be doing at all times

4. They follow that plan 5. They understand what challenges they will likely encounter meaning they are mentally prepared

While the specific details of each trend followers plan vary, there are great similarities in their plans key components. Many people claim that trading is a game. If this is true, and I believe that it is, then there are specific rules that one must follow to win the game. My solution has detailed rules which will increase the likelihood of winning this trading game. It is essential to have a rulebook that will stand the test of time. The rules of these consistently successful traders are remarkably similar. However even with these rules there is no way to mitigate the inherent risks when investing and futures trading might not be suitable for everyone. There are substantial risks while utilizing the strategy of trend following and commodity trading is not suitable for everyone.

An equity curve is a graph that reflects the changes in the value of an account over time. It is a picture that shows you how much money you are making or losing. An upward sloping curve is an indication of profits while a downward sloping curve indicates that there are losses. Someone who is successfully compounding their way to wealth clearly has an equity curve that is sloping upward. Therefore, it is essential that we focus on our curve, and take the necessary steps to increase the likelihood of building our own profitable curve. Do not think that being a trend follower or investing in one gives you an easy 45 degree equity

curve. There will be flat periods in which you do not make any money as well as numerous periods in which you will see your equity curve dip. Regardless of the most stringent risk parameters there will be numerous losses. The goal is to try to keep them small and manageable.

Below is a chart which reflects the effect of compounding over a long period of time: This is an ideal equity curve not found in the real world. There are always drawdowns and losing periods.

Below is an example of a real world equity curve: You will notice there are losing periods and flat periods where there are no profits. As well as you notice over time money was compounded.

My plan to build an upward sloping equity curve is actually quite simple. Please do not be fooled into thinking that this means it will be easy to do as nothing could be further from the truth. To be consistently successful one should have reasonable expectations, a great deal of patience and a good understanding that the power of compounding is the key to building wealth.

Richard Russell began writing the Dow Theory Letters back in 1958. According to him, the most popular piece he ever wrote was titled Rich Man, Poor Man. In that article Russell stated that compounding

is the royal road to riches. He also said compounding is the safe road, the sure road, and fortunately anybody can do it.

Russell believed that in order to compound money successfully you need the following:

1. Persistence 2. Intelligence to understand what you are doing and why 3. Knowledge of mathematical tables in order to comprehend the amazing rewards that will come if you faithfully follow the compounding road 4. Time to allow the power of compounding to work for you Below is a table detailing what would happen to a one hundred thousand dollar ($100,000) investment if one were able to compound that initial investment at an annual rate of between 10% and 20%.

$100,000.00 $100,000.00 $100,000.00 $100,000.00 $100,000.00 $100,000.00 $100,000.00 $100,000.00

10% 10% 10% 10% 15% 15% 15% 15%

5 yrs 10 yrs 15 yrs 20 yrs 5 yrs 10 yrs 15 yrs 20 yrs

$161,051.00 $259,374.25 $417,724.82 $672,749.99 $201,135.72 $404,555.77 $813,706.16 $1,636,653.74

$100,000.00 $100,000.00 $100,000.00 $100,000.00

20% 20% 20% 20%

5 yrs 10 yrs 15 yrs 20 yrs

$248,832.00 $619,173.64 $1,540,702.16 $6,814,608.25

The chart tells us that a $100,000 investment compounding at 15% would grow in excess of $400,000 over a 10 year period. If that investment continued to compound at 15% per year it would grow to over $800,000 five years later.

Below is a chart which reflects an equity curve showing what would happen if one were able to compound money at a 10%, 15%, or 20% return without ever incurring any losses. Of course this would be an ideal curve that investors would be happy to own but this is not the real world. In the real world there are losses and drawdowns.

The problem is that these equity curves DO NOT EXIST in the real world. All trades have uncertain outcomes, and losses are simply an unavoidable part of trading. Using simple math we also learn that it is exceptionally difficult to compound money over a long period of time after suffering a large decline in our portfolio.

Below is a table reflecting the mathematics of recovering from losses:

Starting Portfolio Value $100,000 $100,000 $100,000 $100,000 $100,000

If Your Portfolio Drops 10% 20% 30% 40% 50%

New Value of Portfolio $90,000 $80,000 $70,000 $60,000 $50,000

% Gain Needed to Recover 11% 25% 43% 67% 100%

This table actually shows us that the less you lose, the more you have when things get better. The lesson we learn is that it is very difficult to recover from large losses. While come from behind victories are exciting in the athletic arena, compounding wealth after suffering large losses is exceedingly difficult.

Below is a chart from American Century Investments that shows an equity curve of a portfolio that suffered a 50% decline. This chart indicates just how difficult it is to recover from large losses. A positive 8% compounded return for 8 years will only bring your account back to even after initially suffering such a large loss. It is simply not easy to recover from large losses, and yet all markets will likely suffer 50% declines at some point in time. The power of compounding can work for you only if you do not suffer large losses.

Below are actual equity curves for investors who have compounded their money over time via trend followers who have been trading for decades ( Abraham Trading Group, Chesapeake, Eckhardt, Tactical, EMC, Hawksbill, and many others). While these charts may reflect an upward trending equity curve, one can easily see that there are numerous periods where the curves are either declining or going sideways ( Losing money or at best not making any money). These curves represent what someone might actually experience if they utilize trend following to build wealth. All of these charts are from the website www.Iasg.com which tracks numerous commodity trading advisors. You can search yourself and find even more trend followers.

Abraham Trading Group has been trading since 1988. They have a CAROR of 19.30% and a worst peak to valley draw down of 31.96%. They have returned over 6,100% over all of these years.
PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. THE RISK OF LOSS IN TRADING COMMODITY FUTURES, OPTIONS, AND FOREIGN EXCHANGE ("FOREX") IS SUBSTANTIAL.

Chesapeake Capital has been trading since 1988. Chesapeake has a CAROR of 12.86% over these years. Chesapeakes worst peak to valley drawdown has been 26.66%. Chesapeake has returned over the years 1750%.
PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. THE RISK OF LOSS IN TRADING COMMODITY FUTURES, OPTIONS, AND FOREIGN EXCHANGE ("FOREX") IS SUBSTANTIAL.

Clarke Capital has been trading since 1996. Clarke Capital Worldwide program has returned CAROR of 15.76% over the years. The worst peak to valley draw down was 26.06%. They have returned over 830% over the years.
PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. THE RISK OF LOSS IN TRADING COMMODITY FUTURES, OPTIONS, AND FOREIGN EXCHANGE ("FOREX") IS SUBSTANTIAL.

Eckhardt Trading has been active since 1991. The CAROR of Eckhardt is 21.53%. The worst peak to valley draw down was 40.39%. Eckhardt has returned a little less than 5181% over these years.
PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. THE RISK OF LOSS IN TRADING COMMODITY FUTURES, OPTIONS, AND FOREIGN EXCHANGE ("FOREX") IS SUBSTANTIAL.

Tactical has been trading since 1993. They have a CAROR of 20.65%. The worst peak to valley draw down has been 30.75%. Tactical has returned over the time 3079%.
PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. THE RISK OF LOSS IN TRADING COMMODITY FUTURES, OPTIONS, AND FOREIGN EXCHANGE ("FOREX") IS SUBSTANTIAL.

Blackwater has been around since 2005. They have a CAROR of 17.28%. Their worst peak to valley drawdown is 15.11%.They have returned over 150% over this period of time.
PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. THE RISK OF LOSS IN TRADING COMMODITY FUTURES, OPTIONS, AND FOREIGN EXCHANGE ("FOREX") IS SUBSTANTIAL.

Risk Warning pertaining to the above referenced charts from Iasg.com PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. THE RISK OF LOSS IN TRADING COMMODITY FUTURES, OPTIONS, AND FOREIGN EXCHANGE ("FOREX") IS SUBSTANTIAL. YOU SHOULD CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR FINANCIAL CONDITION. THE HIGH DEGREE OF LEVERAGE THAT IS OFTEN OBTAINABLE IN COMMODITY FUTURES, OPTIONS, AND FOREX TRADING CAN WORK AGAINST YOU AS WELL AS FOR YOU. THE USE OF LEVERAGE CAN LEAD TO LARGE LOSSES AS WELL AS GAINS. IN SOME CASES, MANAGED COMMODITY ACCOUNTS ARE SUBJECT TO SUBSTANTIAL CHARGES FOR MANAGEMENT AND ADVISORY FEES. IT MAY BE NECESSARY FOR THOSE ACCOUNTS THAT ARE SUBJECT TO THESE CHARGES TO MAKE SUBSTANTIAL TRADING PROFITS TO AVOID DEPLETION OR EXHAUSTION OF THEIR ASSETS. THE DISCLOSURE DOCUMENT CONTAINS A COMPLETE DESCRIPTION OF THE PRINCIPAL RISK FACTORS AND EACH FEE TO BE CHARGED TO YOUR ACCOUNT BY THE COMMODITY TRADING ADVISOR ("CTA"). THE REGULATIONS OF THE COMMODITY FUTURES TRADING COMMISSION ("CFTC") REQUIRE THAT PROSPECTIVE CLIENTS OF A CTA RECEIVE A DISCLOSURE DOCUMENT BEFORE THEY ENTER INTO AN AGREEMENT WHEREBY THE CTA WILL DIRECT OR GUIDE THE CLIENT'S COMMODITY INTEREST TRADING AND THAT FEES AND CERTAIN RISK FACTORS BE HIGHLIGHTED. IASG WILL PROVIDE YOU A COPY OF THE DISCLOSURE DOCUMENT AT NO COST. YOU SHOULD REVIEW THE CTA'S DISCLOSURE DOCUMENT AND STUDY IT CAREFULLY TO DETERMINE WHETHER SUCH TRADING IS APPROPRIATE FOR YOU IN LIGHT OF YOUR FINANCIAL CONDITION. THE CFTC HAS NOT PASSED UPON THE MERITS OF PARTICIPATING IN THE TRADING PROGRAMS DESCRIBED ON THIS WEBSITE NOR ON THE ADEQUACY OR ACCURACY OF THE CTA'S DISCLOSURE DOCUMENT. THE INFORMATION CONTAINED ON THIS WEBSITE HAS BEEN PREPARED BY IASG FROM SOURCES DEEMED RELIABLE, BUT IASG DOES NOT GUARANTEE THE ADEQUACY, ACCURACY OR COMPLETENESS OF ANY INFORMATION. NEITHER IASG NOR ANY OF ITS RESPECTIVE AFFILIATES, OFFICERS, DIRECTORS, AGENTS AND EMPLOYEES MAKE ANY WARRANTY, EXPRESS OR IMPLIED, OF ANY KIND WHATSOEVER, AND NONE OF THESE PARTIES SHALL BE LIABLE FOR ANY LOSSES, DAMAGES, OR COSTS, RELATING TO THE ADEQUACY, ACCURACY OR COMPLETENESS OF ANY INFORMATION ON THIS REPORT.

Below is an equity curve that reflects the S&P 500 stock index. As this graph clearly shows, it would have been difficult to compound a portfolio during the last 10 years being invested in the S&P 500. That is not to say the next 10 years will not be better, but my plan aims to avoid long periods where we are unable to compound our portfolios. We must avoid large losses or we will not be able to compound our way to wealth. Equity Curve of the S&P 500 with a compound annual rate of return of 0.39%

If you have followed along so far, hopefully you understand what we are trying to achieve. Next I will talk about HOW we are going to accomplish this.

In my opinion, there are three (3) essential elements in putting together a profitable trading plan. They are:

1. An Effective Method. By this I mean either a trading system or method, which has demonstrated a history of success through all types of market conditions. The method must contain definitive, objective, and operational rules. Remember that trading is a game and therefore we must have a rulebook that will allow us to win the game.

2. Risk Management. Because anything can happen in the markets, we must always act to protect ourselves. A drawdown is a decline from the peak value of an account. For example an account of $100,000 suffering a 10% drawdown will now be worth $90,000. A key issue is that most investors will stop trading after suffering a large drawdown. Therefore, a good risk management plan will attempt to minimize the possibility of that occurring. As Larry Hite commented in the book Market Wizards (1) If you dont bet, you cant win. (2) If you lose all your chips, you cant bet.

3. Discipline. This includes all aspects of trader psychology, self control, persistence, a positive attitude and more. If we understand the game we are playing, then we have a greater probability of being successful. Every game ever played has periods where a player must deal with some level of adversity. If we are prepared for adversity, then we will have a much greater chance of handling it when it inevitably occurs. Mike Tyson once said Everybody has a plan until they get hit in the mouth. There truly is a price to pay for everything and that includes compounding ones way to wealth.

The graph below suggests that the most effective things tend to be the most simple:

Its been said that a good idea could be explained on the back of a business card. Heres the back of my business card: Trade with the trend

 Cut your losses Let your profits run Dont let the big profits get away Trend Following is my personal tool to attempt to compound money over time. Trend following is an investment strategy that tries to take advantage of the trends that occur in the markets. Bill Dunn, John Henry, and Ed Seykota are examples of successful investors who have utilized trend following strategies over the last 30 years. Trend following is based on two simple concepts: 1. You dont need to predict trends to profit from them 2. A handful of big trends can more than make up for numerous small losses In Van Tharps book Trade Your Way to Financial Freedom, Commodity Trading Advisor Tom Basso states: Lets break down the term trend following into its components. The first part is trend. Every trader needs a trend to make money. If you think about it, no matter what the technique, if there is not a trend after you buy, you will not be able to sell at higher pricesFollowing is the next part of the term. We use this word because trend followers always wait for the trend to shift first, then follow it.

My trading plan begins by following markets that are trending. The next part of the plan is essential to understand. After entering into a trade, in what we believe is a trending market, there are only four possible results that exist. They are: A Small Gain A Small Loss A Large Gain A Large Loss

I call this 4 Possibility Thinking.

Now imagine a series of trades over time. Each trade in this series still has the four (4) possible outcomes. If you were able to eliminate the large losses from that series, you would be left with the three (3) other trade results. These now would include some small gains, some small losses, and an occasional large gain. By eliminating large losses, and the time needed to recover from them, you greatly increase the likelihood of compounding your way to wealth. Regardless of the markets you choose to trade, or the plan you wish to use, you will likely experience large losses if your plan allows for them.

Therefore the most critical aspect of the plan we utilize is the elimination of large losses. The essence of 4 Possibility Thinking is the understanding that by eliminating large losses we are left with three (3) acceptable results. The combination of these three (3) results, a small gain, a small loss, or a big gain, is how we plan to successfully build our upward sloping equity curves. Compounding money takes time, and therefore the plan we use must reduce the possibility of suffering a large drawdown. Remember, large drawdowns reduce the likelihood of compounding money which is the goal. Richard Russell, speaking about losing money, said This may sound naive, but believe me it isnt. If you want to be wealthy, you must not lose money; or I should say, you must not lose BIG money. There is only one way to avoid taking large losses, and that is to cut the losses when they are small. Most of us have taken losses that were too large, and it is these losses that make compounding so difficult to accomplish. The bottom line however is there will always be losing trades, there is no perfect system nor perfect commodity trading adviser. Gurus do not exist. Losses will happen more than you like and your greatest drawdown is ahead of you, Not Behind you!

I have chosen to use the commodity futures markets in my trend following plan. The commodity markets are involved in all aspects of our lives on a daily basis. Here are some examples that reflect this:

 We have Coffee and Orange Juice in the morning We use Sugar in our baked products We all love a good piece of chocolate (Cocoa) We eat bread made from Wheat We heat our homes with Heating Oil We put Gasoline in the cars we drive We buy clothes made of Cotton We enjoy a fine steak dinner (Cattle) We invest in the Stock and Bond markets We buy Gold and Silver jewelry We travel abroad and convert our US Dollars into Foreign Currencies, such as the Euro Currency or British Pound We borrow money from banks and pay various Interest Rates (the cost of money)

Commodity markets are affected by many factors, but generally it is the overall supply and demand fundamentals that create price movements in each market.

Supply and demand imbalances create many of the trends that often last for extended periods. These are the trends that we hope to profit from. The simple fact is that the futures markets determine prices for an enormous portion of the U.S. and world economies. A major advantage in using the commodity markets in the plan is that we can profit in both bull markets where prices are rising, and bear markets where prices are falling. The typical stock market investor is dependent on rising prices in order to profit. This means during a long lasting bear market the investor will suffer major losses. Remember, large losses are what we are trying to avoid. My plan, therefore, enables us to trade both sides of a market. With the ability to trade long or short, in rising or falling markets, my plan can profit from lasting trends that move markets in any direction. There has never been a bull market that wasnt followed by a bear market, and we aim to capitalize on the trend which is occurring at the time.

In my trend following strategy we will focus on those items which are both important and which we can control.

A good trend following plan answers the following questions: Which market to buy or sell? When to buy or sell that market? When to get out of a losing position? When to get out of a winning position? How much of a market do we buy or sell?

We cannot control what any given market is going to do in the future, so there is little reason to focus on that.

***What can go wrong and why this is the most important part of the guide***

The above cartoon is intended to let investors know that they will have to do some real work in order to build their equity curves and reach

their goals. If you look closely at some of the equity curves in this book, you will notice that there are many periods where the curves are not rising and are actually going sideways or even declining. Imagine how you will feel when you experiencing those difficult conditions. There will be many instances in which you will be losing money when you are trend following. The only way to avoid losses and drawdowns is not to trade. All investors have a desire to build as smooth an equity curve as possible, but here are some events that may occur while building it: You will have a lengthy series of small losses You will have long lasting periods when your equity curves are flat or declining You will begin to question if the trading method you are using is broken since you are not making any money You will become impatient and look for other places to put your funds Frustration will set in when profitable trades eventually become losing trades You will likely develop a What have you done for me lately attitude? during losing periods

The simple truth is that one way or another you are going to have to deal with some level of adversity. Your ability to handle that adversity will determine whether or not you succeed at compounding money over the long run.

Maintaining the proper mindset during periods of adversity is essential. It is easy to become discouraged and frustrated when adversity sets in. I developed a PEP talk which is specifically designed to reinforce the major theme of this book.

The acronym P.E.P. reminds us of the following:

P: Remembering the Power of compounding is the key, and it takes TIME for compounding to work. E: Reasonable Expectations of what we are trying to do will give us the greatest chance of achieving our goals. Remember our plan is quite simple to understand, but putting it in place will not be easy. We need reasonable expectations to get us through the difficulties. P: Patience is absolutely essential, because without it, we have little chance of hanging in there when the going gets tough.

When we find ourselves discouraged because things arent going well, we must give ourselves a well-needed PEP talk to help get us through the challenges.

Earlier in the book I said the following about the most successful

Trend followers

They understand the power of compounding and their goal is to compound their accounts over time They are NOT big risk takers and are actually more risk averse than one might suspect They have a detailed plan of exactly what they are supposed to be doing at all times They follow that plan They understand what challenges they likely will encounter, meaning that they are mentally prepared

Successful trend followers are ordinary people like you and I, and are not market wizards with exceptional skills and knowledge. If you simply follow the guidelines I have set out in this book, you too will be better equipped to build your own upward sloping equity curve. Realize that commodity trading is not for everyone. There are substantial risks when trading. Loses happen and your greatest drawdowns are always ahead of you. Trend following is not retirement in a box. You need to do your homework.

Paula Webb, in her book Success Without Fear - The RACRS Edge for Traders, suggests there are three (3) steps we all owe ourselves as we strive to reach our goals:

1. Determine exactly what is needed to reach your goal 2. Assess your skills and expertise levels and determine what you need to learn to accomplish your goals 3. Do what needs to be done

Yes, you really can do it. Simply follow the blueprint I have given you. Good luck! One final word: It is very important to maintain an accurate perception of reality about compounding your way to wealth. The obstacles and adversity you face will present challenges. You will 100% go through periods in which you will be losing money. When you begin this endeavor you will quickly discover whether or not this is truly something you want to be doing in the first place. Building an equity curve takes a great deal of time and effort, and is analogous to running a marathon. Longevity is truly the key. As I stated, while the plan itself is simple to understand, executing it will not be easy to do. Trend following and commodity trading is not for everyone. There are substantial risks when commodity trading. You may come to discover that you will be better off finding someone who understands the concepts in this book who has the ability to build you the equity curve you desire. After all, that is the ultimate goal.