The full title of this book is The Trend Following Bible: How Professional Traders Compound Wealth & Manage Risk by Andrew Abraham (2013).
Andrew Abraham is a CTA at Abraham Investment Management, utilizing trend following techniques across multiple markets.
Some good things about the book
- It’s a quick read coming at ~200 pages, with color!
- I liked the fact that the author provided his actual trading results for two accounts. Results were given for the period from end-2009 to 2011 (inclusive). Results showed that with trend following, you have to endure multi-year negative returns to make long-term positive returns.
- The strategies presented are simple and straightforward, essentially the turtles breakout system + MACD + higher time frame MACD.
- The book highlighted many examples of famous traders/investors having bad results, e.g. Richard Dennis losing 50% and closing down his fund, Bill Dunn lost 5 years in a row and had a drawdown of more than 70%, Victor Niederhoffer blowing up twice, Julian Robertson lost billions in a yen carry trade, Dighton lost 80% over a Swiss franc trade, John Paulson having a drawdown of more then 40%, etc.
Some issues with the book include
- Charts are hard to read because they are too small
- Sometimes the words and the chart are not in sync (e.g. figure 8.9, the text talks about February while the chart starts in March)
- Some text can be contradictory (e.g. it wrote that the initial stop for a long position is above the two-bar low, then in the same paragraph it wrote correctly that it should be below the two-bar low.)
- The author wrote in bold “I am giving you my exact plan. There is nothing held back.”, yet the parameters for the breakout strategy (e.g. X-day high, Y-day low, MACD) and retracement strategy (e.g. Elder’s Force Index) are not given.
- Examples given for the breakout and retracement strategies marked as “hypothetical”. I would much preferred if the author used actual trades that he made.
Trade All Markets and Time Frames the Same
- Some traders rationalize that they can just specialize in one market. They are deluding themselves. There will be periods or time frames when nothing seems to happen in any particular stock or market. As well, there will be times in which the volatility will be too great in which they cannot put on a low-risk trade. In reality, I believe that it is extremely hard to always make money in any single market.
- I make myself available for potential opportunities by trading a basket of diversified markets. I never know which market is going to move.
Buy into Successful Trend Followers During Drawdowns
- I look to buy successful trend followers when they have a steep drawdown. It is as if I am buying on sale. Every manager will have a drawdown and this is the time to jump on board.
Calculate Your Risk of Ruin
- Risk of losing one standard deviation = e ^ [-2 * (mean return) / (standard deviation of returns)]
TRADING PLAN FOR BREAKOUTS
Identify the Universe
- Rank all potential markets by a smoothed rate of change
- Smoothed ROC = Average of [ ROC(Close, 2-day), ROC(Close, 5-day), ROC(Close, 7-day) ]
- For stocks
- Use the IBD50 and rank the stocks within this group by the smoothed ROC.
- Also look at 52-week new highs and new lows, and all-time new highs and new lows
- Look to buy the strongest markets and sell the weakest markets, with the hope that they will continue to trend.
Look for a Trend Breakout
- Breakout long
- Buy the X day high and sell the Y day low (e.g. for the turtles, X = 20, Y = 10)
- MACD (not the histogram) must be above zero and increasing.
- Breakout short
- Short the X day low and cover the Y day high.
- MACD must be below zero and decreasing.
Risk Management Rules
- Risk per trade
- Risk no more than 0.75% to 1.25% of your core equity in one trade (equity of all closed positions and cash positions, excluding open trade equity)
- Risk per sector
- No more than 5% of total account size in any sector.
- Open trade risk
- The more open trade risk, the more potential for increased drawdowns. Your biggest drawdowns will probably be after one of your biggest run ups.
- Total open trade equity / Core equity <= 20%
- Margin to equity
- Higher the margin to equity, the more positions and more risk
- Margin / equity <= 15%
- Dollar risk per contract
- No more than $2,500 risk per contract regardless of account size
- Markets in each direction
- No more than 10 markets on the long side; and
- No more than 10 markets on the short side
- For stocks
- Don’t short a stock below $20
- Don’t buy a stock under $10
- Look to go long S&P 500 when it is above 200-day EMA
- Look to go short S&P 500 when it is below 200-day EMA
- Initial stop
- Long: Y-period low
- Short: Y-period high
- Trailing stop
- 39-period ATR trailing stop
TRADING PLAN FOR RETRACEMENTS
Identify the Trend on the Higher Time Frame
- The higher time frames overrule the lower time frames
- Use the weekly MACD (i.e. where the MACD is increasing or decreasing), or a 20-period EMA.
Look for a Trend Retracement
- Long trade
- Weekly MACD is positive and above the zero line.
- Daily time frame there is a pullback via the retracement oscillator (e.g. Alexander Elder’s Force Index) when it crosses below the zero line
- Place a buy stop one tick or 0.001% above the high of the prior two bars
- Short trade
- Weekly MACD is negative and below the zero line.
- Daily time frame there is a pullup via the retracement oscillator when it crosses above the zero line
- Place a sell stop one tick or 0.001% below the low of the prior two bars
- Initial stop
- Long: One tick or 0.001% below the two-bar low
- Short: One tick or 0.001% above the two-bar high
- Trailing stop
- 39-period ATR
- Australian Dollar, British Pound, Canadian Dollar, Dollar index, Japanese Yen, Swiss Franc
- Agriculture Commodities
- Corn, Cocoa, Cotton, Soybeans, Soybean oil, Soymeal, Sugar, Wheat, Livestock Commodities, Lean hogs, Live cattle
- Copper, Gold, Silver, Energy Commodities, Crude, Heating oil
- S&P500, Nasdaq
- Eurodollar, 10-year bond, 30-year bond
Featured Trend Followers
- Salem Abraham, Abraham Trading Company
- Elizabeth Chavel, EMC Capital Management
- Tom Shanks, Hawksbill Capital Management
- William Eckhardt, Eckhardt Trading Company
- Howard Seidler, Saxon
- David Druz, Tactical Investment Management
- Jerry Parker, Chesapeake Capital
- Michael Clarke, Clarke Capital Management Worldwide
- Paul Mulvaney, Mulvaney Capital Management
- Bernard Drury, Drury Capital
- Jeff Austin and Andy Silowitz, Blackwater Capital Management
- Justin Vandergrift, Chadwick Investment Group
- MetaStock: For backtesting and automated trading.
- Tradingblox: For walking forward on a portfolio level.
- IASG: For looking at performance of CTAs