Forex Trading Tips: Why the Trend is Your Friend

Why The Trend is Your Friend

This week I wanted digress from our usual format and discuss an interview with Bill Dreiss in the April 2009 issue of Active Trader magazine which I believe carries many useful insights on the art of trading. Mr. Dreiss has been successfully trading markets longer than most of us have been alive and while he is a strict systems guy while we at BKT are discretionary traders I agree with many of his observations and think its worthwhile to examine them in more detail.

Bill Dreiss has been trading since the early 1970's before there was even a CFTC and a CFA accreditation, so it is fair to say that he has seen just about every type of a market environment there is, noting himself that "I've trading long enough that as far as I am concerned there is nothing new under the sun." More importantly Mr. Dreiss has managed to not only to survive but to prosper for 40 years, and if there is one factor that you should prize in trading above all else it is longevity.

Not only is this game hard to master on a day to day basis, but it is extraordinarily difficult to maintain performance over the long term. Take anyone from a technician like the Elliot Wave guru Bob Prechter, to the ultimate fundamental investor like Warren Burret and you can see that irrespective of what side of the spectrum you stand on - long term success for even the best traders can be extremely elusive.

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Mr. Prechter of course flamed out after the 1987 crash stubbornly calling for Dow 700 while the market started its greatest bull run in history of mankind and Warren Buffet- the "world greatest investor" now finds himself in such a mess financially that the cost of CDS insurance (the cost of insuring against the bankruptcy of Berkshire Hathaway debt) is now higher that that of Vietnam sovereign debt.

All the more interesting then to hear what Mr, Dreiss has to say given the fact that he has averaged nearly 19% compounded rate of return over the past 15 years and never had more than two losing years in a row. Mr. Dreiss message is actually quite straightforward and relatively simple."If you've done your own research, as I have, its clear that markets exhibit persistence, which over the long term favors trend followers and weeds our strategies that favor risk aversion. Al that means is if a market is headed in a certain direction, its more likely to continue in that direction that it is to go in the other direction."

Our whole BKT model is based around that central premise. We effectively look for two types pf trades - a breakout to trend or a retrace to trend opportunity. Of course those are not the only criteria we use, but unless we have the underlying framework we wont even consider a trade. None of this assures us of success, but it does increase our probabilities in the long run and that is all that we can ask for.

Trend traders often get eviscerated in choppy range bound environments and many novice retail traders when faced with this problem often like to resort to "reversion to the mean" trades averaging up or down into the position hoping that it will come back to profit. To that Bill Dreiss offers perhaps the strongest and best rebuke I have ever read anywhere so I will simply quote him at length.

"Suppose you go to Las Vegas and instead of playing a fair game where the chances are equal that you'll win or lose, you are playing a game that's actually stacked against you a bit. Nevertheless, you can double down and make money right? Just use the standard doubling down strategy and you'll always make a steady return - as long as you don't run out of money. That's what Wall Street and many hedge funds do.

But the problem is, every now and then you run out of money. That's what happened to LTCM. when the investmnet banks came in and bailed it out they learned to use the same approach. It's a great strategy - if you can run it for several years and collect 2 percent management fees and 20 pecent incentive fees off of it, you can make a fortune. And when the thing blows up you don't have to pay the money back.

This is the con game Wall Street has been running for at least the past couple of decades, which is now coming up apart. Madoff is considered a crook because he ran a Ponzi scheme, but it's all a Ponzi scheme."

Now on to this week’s video - which after all my effusive praise for trend trading focuses on what? Counter trend trading. But ask you to listen to teh video carefully, because this strategy is very specific so practice at your own risk.

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