The short answer to ‘Why’ is: you are already doing a part of the strategy and don’t realize it. Therefore, you are missing a critical piece and are losing the great results you could be getting.
I’ll explain in just a minute.
So what is Trend Following?
It is a Technical investing strategy, the essence of which is: Ride your winners; Cut your losses
According to Michael Covel, in his book, Trend Following: How to Make a Fortune in Bull, Bear and Black Swan Markets (5th Edition, 2017)
“Let’s break down the term Trend Following into its components. The first part is “trend”. Every trader needs a trend to make money. If you think about it, no matter what the technique, if there is not a trend after you buy, then you will not be able to sell at higher prices…”Following” is the next part of the term. We use this word because trend followers always wait for the trend to shift first, then “follow” it.”
The explanation is direct and simple but can be complicated to execute.
What causes the price of a stock to increase?
Basically, institutions, various funds and individual investors are buying it which causes the price to rise. That stock is in favor with investors and the price continues to show it.
We are not talking about ‘spikes’ or quick upticks in price of short duration. We are talking about prices that continue to increase over time slowly and steadily. For example, a Southwest Airlines trend started September 2012 at $9 and ran for more than 2 ½ years to $43. Those are the kinds of trends we LUV.
However, many trends are much shorter. And there are most definitely losers!
Hence the dictum: Ride your winners; cut your losses!
The trend has to materialize (what to buy) before trend followers invest. So, it is rare to buy at the beginning of a trend. It is also next to impossible to sell at the top of the trend.
That is why those who follow a Trend Following strategy always focus on Risk Management.
The exit strategy (when to sell) is just as important as an entry strategy (when to buy), in fact, more important! You want to lock in profits gained from riding winners just as you want to cut losses on stocks in which the trend has faded. There are frequently more losers than winners but keeping those losses small is key. No riding the stock or the market down!!
In Trend Following, investors determine their exit strategy before they buy. They assess the stock and calculate a reasonable stop loss position based on volatility not on emotion. If the trend falls below the stop price, the investor is out. And ready for the next trend.
This is one basic difference between a Trend Follower and a Buy and Hope investor.
When the trend fades and the price drops, the Buy and Hold investor continues to ‘hold’ because they think, “well, this is a good stock, and it might turn around.” It might. Today, tomorrow, months from now, years from now or never. The road to success is strewn with companies that didn’t turn around.
There is another catch phrase in investing. “Buy Low. Sell High.” It is not Buy Low. Hold Forever.
And why should you care?
Because you may not only be missing profit opportunities; you may be putting your hard-earned money at greater risk due to market downturns.
Here’s how you might be employing part but not all of a Trend Following strategy.
When you decide to invest some of your hard-earned money, you begin by looking for good stocks to buy. You may ask a friend what they are considering. You might watch CNBC, Fox Business or read a financial magazine. Basically, you are looking for a company whose stock is likely to grow; to increase in price. You are looking for a stock whose shares are likely to trend higher. Why? Because that is the way you grow your profits and your wealth.
You are creating an “entry point” but not a strategy.
Do you have an ‘exit strategy’? If not, your hard-earned money and investments are at greater risk. Are you locking in profits as well as managing downside risk? Are you using prudent trailing Stop Loss orders?
The object of investing is to grow wealth for your financial security, to have a better future and certainly a better retirement. Trend Following strategy can be a great option for a portion of your investing dollars.
See how Trending Stocks can help you ”ride your winners and cut your losses” here.
