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Module 1, Topic 1
In Progress

Trend Following for the retail traders

This is an amazing post by Jason Klatt, a Trend Follower who manages a fund of more than $100 million.

Here is what he has to say about Trend Following...

"I went through Michael's "Turtle Trader" research years ago. I can't remember the exact name of it, but it was the one he sold at the time (10+ years ago). It had a turtle looking thing on the cover. I'm not sure how his research has evolved since then.

I definitely found value in it. It opened my eyes up to some new concepts. Concepts I use today and concepts I used to manage hundreds of millions of dollars. If you're looking for something that actually works, trend following is your man. And Michael is certainly a leader in the space. I'd absolutely recommend spending money on something like that instead of your run-of-the-mill "learn how to day trade and extract $200 per day from the markets" mentorship.

That being said, what might not be so obvious about trend following is that a full-featured, long/short, authentic trend following program (the likes of what Dunn Capital, Mulvaney, Winton, Milburn, Tactical, etc. do -- the "Managed Futures" category) is likely out of reach for your average US retail trader. Authentic, full featured trend following requires 1) a diversified universe of instruments to trade and 2) leverage. Without both, you'll be hard pressed to generate the risk adjusted (and absolute) return profiles these managers have produced.

Typically, managed futures trend followers trade a portfolio of 100+ globally diversified exchange-traded futures contracts. From the likes of Corn to Wheat to London Sugar and New Zealand Bank Bills. They trade four different asset classes (stock index futures, fixed income like short rates and government bonds, commodities and currencies) across several different continents/time zones (North America, Europe and Asia/Pacific Rim). The problem that the average retail trader runs into when trying to implement such a program is capital. Go to the CME's (Chicago Mercantile Exchange) website. Take a look at the margin requirements for their various futures contracts. Look up the maintenance margin for the S&P500, British Pound, Live Cattle, Crude Oil and Soybeans. The maintenance margin is how much capital you need on deposit with your broker to simply hold the position. It's a considerable amount of money for just those 5 positions alone and in order to "do it right" you'll need to be able to hold many more positions than that.

If you don't have that kind of money, you do have some options and workarounds. If you live outside the USA (it doesn't look like it, but I'll share anyway), you could look into trading CFDs. There are certainly risks associated with doing so and I highly recommend looking into those risks before doing so, but CFDs provide the granularity (think fractional shares of futures contracts where you can buy 0.10 contracts of Corn instead of being forced to purchase in increments of 1 whole contract) you need to trade a globally diversified set of futures contracts on a small account.

Another option would be to use ETFs as a proxy for the futures contract. For example, you could trade the COW ETF instead of the Live Cattle exchange traded futures contract. This gives you the granularity you need, but the big drawback to trading the ETFs is leverage. The SEC doesn't afford securities traders nearly the amount of leverage the CFTC does in the futures space. At best you'll be able to leverage up your COW position at 2-1 (the futures contract is more like 10-1) and you'll have to pay margin interest on your leverage (which right now costs around 6% annually -- which will definitely eat into your returns).

Another option would be to do this in the forex markets. The forex markets are great because there's considerable diversification there (50-100+ pairs to trade) AND you can trade in really small increments. So you CAN create a full featured trend following program in that space, but it won't be nearly as diversified as an authentic managed futures program which has access not only to currencies, but also to stock index futures, fixed income and commodities (which can be a big deal).

And lastly... you could look into doing it on individual stocks. With the advent of fractional shares, you can can trade a diversified universe of securities (think all the stocks in the Russell 3000 or S&P500) because you're able to buy 0.0003 shares of GOOG these days. But again, the hurdles you'll run into there are trading costs and leverage. Many retail brokers charge $5-10 per trade and if you're looking to trade 100+ (or even a 1000) stocks at the same time, the trading costs are prohibitive. On top of that, you've also got issues with leverage. Again, you can only lever up 2-1 and there aren't many brokers out there that offer fractional shares with margin and reasonable trading costs.

So... what's my point? My point is that trend following kicks ass. It works. It's the only strategy out there that has 100s of billions behind it and decades of outstanding performance. If you're interested in trend following, it's a worthwhile endeavor and there's some real, substantive value to be found there. Michael is certainly a leader in the space and I'm sure you can't go wrong learning from him. I found value in some of his work and I'm sure you will too. The only place you might be let down is in the actual implementation. Get clearer on what your goals are as a trader. What kind of returns are you looking to generate? And then better understand what it takes to actually DO that. Are you looking at Mulvaney's returns and thinking "Holy shit! I want to do that!" If so, buyer beware. You might not be able to actually DO what they're doing. Meaning, you might not be able to generate the risk adjusted (and absolute) return profiles of these elite managers because you simply don't have enough capital to fund such a trading program."