I saw a recent tweet talking about how losing trades can be more instructional than winning trades. I happen to think that, for a trend follower, you can learn more from winning trades.
A famous example of this is the heating oil trade taken by the Turtle traders, which occurred during their initial training period early in 1984.
Now, out of the group, the story goes that only one trader was able to get on a 'fully loaded' position and then fully follow the rules given to them by Richard Dennis and William Eckhardt - and that was Curtis Faith. And therein lies an important psychological lesson for people who are attempting to trade using a trend following approach.
In his excellent book Way of the Turtle, Faith talked about this trade in detail, and how some of the group dealt with a minor pullback in the prevailing trend:
"It was very clear that the right thing to do during a brief drop was to hold on and let then profits run.
Upon seeing profits evaporate, the few Turtles who had significant positions liquidated their contracts.
I was rewarded for holding to the methods we were taught by earning almost three times as much on this trade as any of the other Turtles did. The few who had positions of a reasonable size had all exited near the lows of the previous dip and ended up missing half of the move. The Turtles who had not entered the trade made nothing.
The difference in return had nothing to do with knowledge and everything to do with emotional and psychological factors.
Over the years I kept finding evidence that
emotional and psychological strength are the most important ingredients in successful trading. This was my first exposure to that idea and the first time I had seen it in action."
In my experience, the vast majority of aspiring trend followers have no difficulty in cutting losing trades - taking the small losses when a potential new trend fails to develop.
The biggest problem they have is letting the winning trades run. This is where patience and discipline are required, and can be a direct result of your mindset.
If this is something that you struggle with, then you are in good company. As we can see from the Turtles story, it appears that some of the group (which included people who became some of the most successful traders from the past 30 years) also initially struggled with it. So, it can be overcome.
Indeed, seeing such a major trend develop early on in their time trading for Richard Dennis undoubtedly will have played a major role in reinforcing the need to let the winning trades run.
Trend following is generally regarded as a 'fat tail' method - it is those very occasional big winning trades that power the overall returns, and cover the multitude of small losses. Therefore, to generate the overall positive expectancy, it is crucial that you let those winning trades run. If you don't, then you won't have the positive expectancy - it's that simple.
Whenever you are tempted to cut a winning trend short, keep in mind the following Richard Dennis quote from his Market Wizards interview:
"The correct approach is to say: This structure means up, and this structure means up no more, but never that this structure means up this much and no more."
If you are following a series of rules which allows you to determine whether price is trending or not, then it is that framework which should drive what you are doing. A lot of the time, this may mean doing nothing.
Generally speaking, trend following methods and the exit rules contained within will automatically take you out of the trade. As a trend develops, all you need do is update the trailing stop based on your rules. You shouldn't need do anything else.
In other words, if your stop isn't hit, you should stay in the trade - everything else is just 'noise'. As far as trade management goes for a trend follower, it simply becomes a question of updating your trailing stop. And the market will decide when you will exit such a trade.
It should be said however that, with this particular heating oil trade, the position was manually closed as the February contract was coming up to expiry. Why? Because the trend only existed in the February contract, so there was no need to rollover the trade.