A Simple Trend Following Strategy (Backed By Data)

Key Concepts

• Trend Following: A trading strategy that aims to profit from sustained price movements (trends) in financial markets.
• Futures Trend Following: A specific type of trend following that originated in the futures market and can be applied across various asset classes.
• Trailing Stop-Loss (TSL): A risk management technique that automatically adjusts a stop-loss order as a trade moves in a profitable direction, helping to lock in gains and limit losses.
• Average True Range (ATR): A technical indicator used to measure market volatility. In this context, it's used to set the trailing stop-loss distance.
• Donchian Channel (Closing Price Modified): A technical indicator that plots the highest high and lowest low over a specified period. The modified version used here focuses on the highest closing price.
• Chandelier Exit: A trailing stop-loss indicator based on ATR, designed to exit trades when a trend reverses.
• Drawdown: The peak-to-trough decline during a specific period for an investment, fund, or commodity.
• Payoff Ratio: The ratio of average profit on winning trades to average loss on losing trades.
• Winning Rate: The percentage of trades that result in a profit.

Trend Following System Performance and Philosophy

The video introduces a trend-following trading system that has reportedly generated 2,864% over the last 25 years, with an approximate 14% annual return and a maximum drawdown of 37%. This performance is presented as superior to a buy-and-hold strategy on the S&P 500, offering higher returns with lower risk. A key characteristic highlighted is the system's ability to perform exceptionally well during market crises and recessions, such as the dot-com bubble (2000), the 2008 financial crisis, and the Russia-Ukraine war.

The core philosophy of trend following is to capture the "meat of the move" by riding trends across different asset classes, profiting in both bull and bear markets by going long and short. The strategy emphasizes trading as many markets as possible to increase the probability of capturing a trend.

Trading Rules and Methodology

The trading system is described as remarkably simple, with just two core rules:

1. Entry Rule (Long): Go long when the price closes higher than the highest closing price over the last 200 days.
2. Entry Rule (Short): Go short when the price closes lower than the lowest closing price over the last 200 days.

Exit Rule: A 6 ATR (Average True Range) trailing stop-loss is used to exit trades. This means the stop-loss is set at a distance of 6 times the current ATR below the highest price reached since entering a long trade, or above the lowest price reached since entering a short trade. The stop-loss is adjusted upwards (for long trades) or downwards (for short trades) as the price moves favorably, but it never moves against the trader.

Technical Indicators and Tools

The video demonstrates the application of the system using specific indicators available on TradingView:

• Donchian Channel (Closing Price Modified): This indicator is used to identify the entry trigger. The specific version recommended is found by searching for "Donchian Channel bracket closing price" and setting the period to 200. The blue line on the chart represents the highest closing price over the last 200 days.
• Chandelier Exit: This indicator is used for the trailing stop-loss. The recommended settings are 6 ATR and a 20-period lookback. The green line on the chart visualizes this trailing stop-loss.

Step-by-Step Example: Coffee Trade

A detailed example of a long trade on coffee is provided:

1. Waiting for Entry: The market is observed until the price touches the blue line (highest closing price over the last 200 days).
2. Entry Trigger: When a candle closes above this blue line, it signals a potential entry. The actual entry is taken on the opening price of the next trading day to confirm the breakout.
3. Trailing the Stop-Loss: The Chandelier Exit indicator (green line) is used. As the price moves up, the green line also moves up, trailing the stop-loss.
4. Enduring Volatility: The example emphasizes that trend following requires enduring significant price fluctuations, pullbacks, and periods where the stop-loss is nearly hit. This tests the trader's emotional resilience.
5. Exit: The trade is exited when the price closes below the green trailing stop-loss line. The actual exit is executed at the opening price of the subsequent trading day.

Backtested Results and Performance Metrics

The backtested results over 25 years reveal the following:

• Total Return: 2,864%
• Annualized Return: Approximately 14%
• Winning Rate: Approximately 45% (meaning a 54% losing rate)
• Payoff Ratio: 1.74 (average gains are larger than average losses)
• Maximum Drawdown: 37%

The data highlights that trend followers do not make money every month or year. Crucially, the system performs exceptionally well during crises:

• Dot-com Bubble (2000): +22%
• Financial Crisis (2008): +65%
• COVID-19 (2020): +8%
• Russia-Ukraine War (2022): +56%

The video also shows exported Excel data illustrating periods of significant drawdowns, where the equity curve might remain flat or decline for several years, underscoring the psychological challenge of this strategy.

Pros and Cons of Futures Trend Following

Pros:

• Low Correlation to Stock Market: Offers diversification benefits for stock investors.
• Performance in Bear Markets: Tends to perform well when traditional stock markets decline.

Cons:

• Low Winning Rate: Typically between 30-45%, which can be psychologically challenging for traders.
• Psychological Test: Requires significant emotional resilience to endure drawdowns and frequent small losses.

Mitigating Drawdowns and Enhancing Strategy

The presenter suggests that combining trend following with other trading systems or investment strategies can help alleviate the pain of drawdowns. For instance, if stock investments are performing well during a bullish market, they can provide a cushion while trend following might be in a less profitable phase. Conversely, when stock investments suffer during a downturn, trend following can shine, offsetting losses.

Free Training Offer

The video concludes with an offer for free training at tradingwithra.com/go. This training includes:

• Three rule-based trading strategies backed by data.
• Detailed trading rules, entries, exits, and risk management.
• Chart examples.
• PDF slides of the training.
• Trading strategy cheat sheets.
• Backtest reports for all strategies.

Synthesis and Conclusion

The presented trend-following system offers a compelling historical performance, particularly its ability to generate profits during market downturns. The strategy's simplicity in rules (highest close over 200 days for entry, 6 ATR trailing stop for exit) is contrasted with the significant psychological fortitude required to endure its low winning rate and substantial drawdowns. The system's low correlation to traditional markets makes it a valuable tool for diversification. The presenter emphasizes that while the strategy is robust, managing emotional responses and potentially combining it with other approaches are key to long-term success. The offer of free training provides access to this strategy and two others, along with supporting documentation.