Trend Following: Low Risk Breakout Strategy

Trend Following: Low Risk Breakout Strategy BY ANDREW ABRAHAM

Trend following is a strategy that has been used by traders for decades. Bull markets, bear markets, inflation or deflation–trend following has proven itself. Trend following can be used on stocks, forex or commodities as well as on any time frame.

Trend following with a plan tells you exactly:

• What to buy

• How much to buy
• When to exit with a profit or a loss

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In order to succeed in trading you need an exact plan, risk management and proper trading psychology. Miss one of this attributes your chances of success are lessened.

First, I identify the strongest markets and the weakest markets. This is done by ranking the markets via relative strength or rate of change. Relative strength or rate of change can be found on most trading platforms. This defines the universe in which I am looking for trades. The concept of trend following is based on strong markets to continue and weak markets to continue to weaken.

The next step is to look for a break out trade or break down trade if I can put on a low risk trade. Firstly the concept of a break out trade is based on Richard Donchian who was a trend follower from the 1940s till his death almost 50 years later. The breakout trade was enhanced by the concept of the so-called “Turtle Traders.” It is very simple. Buy the 20 bar high and sell the 10 bar low (You can use any variation of this).

RISK PARAMETERS

However, I will only look to take a break out trade if I can put on a low risk bet. A low risk bet is risking no more than 1% of my account size. For example I have a $100,000 account size I do not want to risk more than $1,000 dollars. In order to determine this 1% risk I measure the distance from the X bar high to the Y bar low. For example if the distance from the X bar high to the Y bar low is 5, I have a $100,000 account size and determine I want to risk 1% I can trade 200 shares.

I have a bias to the long side as those trades can continue without limit, and shorts are limited. As I mentioned earlier, risk management is one of the principles that will keep you in the marathon of trading. In order to survive long term, I also limit my total allocation per sector as well as I limit my total risk on my open trade equity. I always want to trade with the trend. I look at moving average convergence divergence (MACD) and look to go long when it is above the zero line and increasing and vice versa for shorts.

SET-UP

Exemplifying the above is an example of Apple at the end of 2011. Apple on a relative strength basis was one of the strongest stocks. See Figure 1.

GETTING IN

On Dec. 20, 2011 there was a breakout signal at $395 which was a 20 day high. The initial risk was to the 10 day low. You should not risk more than 1% of your account size on any trade. In order to determine how many shares take the difference between the 20 day high and 10 day low and divide it by 1% of your account size to determine.

GETTING OUT

Once the trade started working you would have followed the trade with patience and discipline until you received a signal to exit by a violation of a trailing average true range (ATR) stop. On April 16, 2011 Apple violated the ATR trailing stop and you would have exited.

Trading in this methodology is robust and an extremely powerful of extracting profits out of trending markets.

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About the Author

Andrew Abraham is the author of The Trend Following Bible, published by Wiley.

Easily Identify Trend With Bollinger Bands

Easily Identify Trend With Bollinger Bands BY MARK HODGE

Markets move in three directions: up, down, or sideways.

Sounds pretty simple, right? Then why is it so difficult to be on the right side of the market? Market direction is one of the most important factors to consider when entering the market, and a factor that is often overlooked when blindly trading a strategy. Can chart reading improve your strategy’s performance? I believe so, and in this article I’ll introduce one of my favorite indicators and how this indicator can be used with any strategy to help put you on the right side of the market.

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Before we begin, it’s important to understand the type of strategy that you are trading. There are thousands of strategies and ways to trade the market, but it always comes down to two fundamental methods: trend-following and trend-fading.

Trend-Following – Strategies developed to identify and enter a market that is trending. The goal of a trend-following strategy is to trade with the trend (buy highs and sell higher, sell lows and buy lower).

Trend-Fading – Strategies developed to identify and enter a market that is moving sideways. The goal of a trend-fading strategy is to trade against the trend (sell highs and buy lower, buy lows and sell higher).

Knowing that strategies fall into the two categories above, it’s important to use chart reading techniques to ensure that you are trading a strategy in the right market environment. If you are using a trend-fading strategy, do you know how to avoid getting caught in a trending market? If you are using trend-following strategies, do you know how to spot markets that are trending and more importantly, when a trend might be coming to an end? It all comes down to chart reading and in my experience Bollinger Bands are the easiest indicator for understanding market direction.

THE BASICS
If you’re new to Bollinger Bands, the indicator consists of three bands: The Upper Bollinger Band, the Moving Average, and the Lower Bollinger Band. The standard setting for the moving average is 18 or 20, but I adjust this setting to 12 for day trading. Standard deviations of the moving average are used in order to plot the upper and lower band. The standard setting is 2 and this is the setting I use for my trading.

CHART SIGNALS
So in a nutshell, this is how I use Bollinger Bands to read the market:

UPTREND = If price is tagging the Upper Bollinger Band and the Upper Bollinger Band is clearly pointing up.

DOWNTREND = If price is tagging the Lower Bollinger Band and the Lower Bollinger Band is clearly pointing down.

SIDEWAYS = If both the Upper and Lower Bollinger Bands are both flat.
SOME EXAMPLES
To understand exactly what I’m looking for, let’s look at a few charts. I’m charting a 20 tick range bar of Crude Oil with the Bollinger Band settings above. Since the moving average is important for plotting the upper and lower band, but not used for chart reading, I’ve removed it from my charts.

In the chart above you’ll see trends identified when price is clearly tagging the Lower Bollinger Band (downtrend), or the Upper Bollinger Band (Uptrend). The blue arrows show sideways conditions. Traders should consider using trend-following strategies when Bollinger Bands are pointing to the possibility of a trend, and trend-fading strategies when Bollinger Bands are indicating that the market is moving sideways.

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A NEW TWIST
If you’ve worked with Bollinger Bands before, you might be surprised to hear that they can be used to identify trends. Since Bollinger Bands with a standard deviation of 2 contain approximately 95% of all price points, it’s easy to assume that Bollinger Bands should just be used with trend-fading strategies. In fact, this is how many traders first learn how to use Bollinger Bands (sell at the Upper Bollinger Band, buy at the Lower Bollinger Band). As you can see Bollinger Bands are much more versatile, and although bands can be used to identify relative highs and lows, simply buying the lower band and selling the higher band is not a good way to trade unless chart reading is used to identify sideways conditions.
In addition to identifying ideal conditions for entering the market, Bollinger Bands can help you if you are in a trade and market conditions are changing.

In the chart above, we see a nice uptrend. After a nice sideways range, we see price pushing higher and tagging the Upper Bollinger Band. Let’s assume we had a long entry at 103.83. As price continues to push higher, tagging the Upper Bollinger Band, the trend continues. On the 5th bar after our entry we see a bar closing lower. This would be the first concern the trend could be weakening, but with the Upper Bollinger Band clearly pointing up, there’s no reason to panic. However, after the next bar closes higher, price is starting to pull away from the Upper Bollinger Band. Two bars later the Upper Bollinger Band is flat, a sign that the trend is over.

Let’s now look at the opposite scenario in a downtrend…

In the example above, let’s assume that we entered the market short at 104.48, when price was clearly tagging the lower Bollinger Band. The next two bars close lower and we have a nice downtrend. Looking at the 4th, 5th, and 6th bars, price has pulled away from the lower Bollinger Band (a sign that the trend might be weakening), but the lower Bollinger Band continues to point down.

If we are concerned about the trend continuing, we could move our stop loss to breakeven when price starts to pull away from the lower Bollinger Band. In this example, price continues lower for the next few bars. At the completion of the 8th bar of the trend, the lower Bollinger Band is flattening out. If we weren’t convinced that the lower Bollinger Band was sideways we could wait one more bar. However, we definitely want to close the trade at the completion of the 9th bar (104.24 close). Why? At this point the band is not only sideways, but actually pointing up, a clear sign that the trend is over.

THE TAKEAWAY
Bollinger Bands are a great tool for reading market conditions and for understanding whether the market is likely to move up, down, or sideways. Try combining Bollinger Bands with your favorite strategies or indicators to see if they help you with reading market direction and your trading.

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About the Author

After stints with Morgan Stanley Dean Witter and American Express Financial Advisors, Mark discovered that his real passion was trading. With a trading and investment background that spans more than 15 years, Mark’s expertise lies in the short term trading of stocks, options, and futures. With an extensive knowledge of technical analysis and money management, Mark has been featured by SFO Magazine, Technical Analysis of Stocks & Commodities, AllExperts.com, INO, FXstreet, Traders’ Library, Active Trader and other leading publications and websites in the trading industry. As Head Coach at Rockwell Trading, Mark is co-developer of many of Rockwell Trading’s educational resources, and works on an individual basis with traders around the world. Mark lives with his family in Sacramento, California.

Trading: Trend Following vs. Counter-Trend

Trading: Trend Following vs. Counter-Trend by Pristine.com

If there’s one trading dilemma that tends to inspire the most heated discussions among professionals and novices alike, it would have to be the one dealing with the decision to trade “with the trend” or “against the trend”. Countless books have been written on the subject, and although there are no definitive answers, I’ve decided to set the record straight in regards to the realities of these two approaches and the proper way to handle each.

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First of all, let’s define these two approaches for greater clarity. For our purposes, we’ll consider “trend following” any strategy looking to take advantage of a directional move in the context of an existing trend within the timeframe in question. This requires that we make sure that there is an existing trend and then looking for tradable patterns to take advantage of a continuation of said trend. Technical traders learn to recognize the parameters that define a trend, and then look to “cherry pick” among the healthiest trends available (Ref. Trading the Pristine Method(R) (TPM) and Advanced Technical Strategies (ATS) seminars). On the other hand, “counter-trend” strategies revolve around taking advantage of perceived “excesses” in the directional move of a trend, looking to capture the retracements toward some form of “median” or “support/resistance” area. Although I’m obviously biased toward one of these styles (Trend following), allow me to discuss the pros and cons of each and the way to use each style to obtain the best results within a given trading environment.

Trend-following styles base their approach on a simple principle: The trend displays the direction of the group in control (Buyers or sellers) and thus, trend-following traders will want to take positions using reliable patterns to try and take advantage of this potential continuation of the current direction, at least until the trend changes. These traders have developed “objective” ways to define a trend, its quality and odds of continuation. The idea is a rather simple one…trend-followers want to swim with the current. Whenever there’s an established trend, the group in control (buyers for uptrends and sellers for downtrends) tends to push prices in the direction of the trend, at least until the imbalance of supply/demand created ceases to exist. Such imbalances create “momentum” that helps them achieve larger moves when they’re right. How long can any given trend last That’s anyone’s guess, although the analysis of supply/demand levels (Ref. Pristine’s ATS seminar) can sometimes help determine that with great precision. There will be a time when trading in the direction of a given trend becomes higher risk, because the trend could be “extended” or nearing support/resistance areas. In the end, these traders will have confidence in the trend at hand as long as the objective conditions that created and fuel the trend remain in place, looking to trade the patterns included in their respective Trading Plans within the trend. When said trend changes, they’ll reevaluate the trading direction and use a new set of tactics better suited to the new trend.

Counter-trend traders try to capitalize from those “retracements” toward the median price that typically take place within a trend. If you take any given chart displaying a decent trend, you’ll notice that these “retracement” moves do happen, but when compared with the usual moves in the direction of a trend, they tend to be smaller in size and shorter in time. Execution also tends to be an issue when dealing with “counter-trend” trades, as the act of swimming “against the current” makes for greater levels of “slippage” when stops are hit (In many cases the “stop” of a counter-trend trader will be the entry signal of a trend-follower” and since the trend is in the opposite direction…). That’s not to say they’re not tradable, but the clues mentioned above should set the stage for the way in which a Pristine Trained Trader should normally handle these (Usually as short-term “scalp” trades instead of looking for holding periods similar to those that usually are expected when taking a “trend-following” position). The Pristine Method(R) seminar series teaches traders very specific parameters to trade some of these “counter-trend” events, looking for just those with the greater odds of producing a decent move.

In the end, I’m a trend-following trader for most of my trades, looking to focus on the direction created by the stronger group of traders. Then I’ll apply the strategies I learned in my Pristine education to profit from these trends, and when the trend changes I’ll have the necessary objectivity to change with it. That’s the professional way.

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About the Author

Our mission is to create smarter, better informed, successful traders and investors by creating and providing the highest quality trading education available anywhere in the world. By teaching the growing community of self-directed individuals The Pristine Method of trading, we help empower and enlighten the individual, open the hidden door on Wall Street, andteach not only what to do in the markets, but when to do it, where to do it, and most importantly why it should be done.