Trend Following for Equity Traders
What type of trend following systems do you use?
In Unholy Grails I talk about trend following for equities traders. We run through eight different strategies and put them to the test. The last strategy, the Bollinger band breakout, is loosely based on what I do. It’s using Bollinger band. I don’t think simple breakout time strategies are overly effective, not for equities anyway. I think you’ve got to have a little bit more volatility added in there, and the Bollinger bands do that.
I recently wrote another eBook called The Weekend Trend Trader, which is a weekly trading system, specifically designed for the U.S. market. Whilst this is a breakaway style strategy, it has another confirming indicator in there that keeps you out of certain trades. I guess back in the early 90’s; I used to trade a strategy very similar to aberration. Aberration was a very famous commodity trading system back in the 90’s. It kind of became too popular, and was ebbed out effectively. It was a Bollinger band based trading strategy as well. One of the little filters I added in there is only taking certain trades to give me the best bang for my buck. If there was a breakout and the risk from the trade was too high, but your position size was so small that it really wasn’t worth it, I’d skip the trade. That made quite a significant difference to the bottom line.
I guess in simple terms the strategy I trade now is based on that Bollinger band strategy. We do everything else out of that book. We use what’s called an index filter. An index filter simply defines the broader market trend. If you think of the old adage arising tide lifts all boats, falling tide drops all boats: back in 2008 not many stocks were going up. To put the probabilities on your side, you would take buy signals when the broader market was trending up.
The first question we ask is, “Did broader market trend up or down? Yes, or no?”, if the answer is no you don’t take any buy signals. If the answer is yes, then you go down to an individual stock level and find the criteria to buy whatever that may be. In our case it’s a breakout of a Bollinger band. That keeps us on the right side of the market.
The other thing we do, if we do have open positions and the broader market trend turns down, we will tighten the stocks up. We won’t close the positions but we tighten the stocks up. We leave the door open quite wide when the market is trending up, but as soon as the market starts trending down we close that door substantially to lock in any open profits, and that works well. Interestingly enough, that same index filter, we use that across the board on all our strategies –even our short term high frequency strategy that we operate on the Russell 1000 stocks. We will only take positions when the broader market is trending up.
