The Importance of Trend Following in Stock Market Investing
By John Lohmeier
"It is the direction of the price movement that counts. It is always probable, but never certain, that the direction of the price movement will continue. Soon after it reverses is time enough to sell. You should sell when you wish you had sold sooner, never when you think the top has arrived. That way you will never get the very best price - by hindsight your individual transactions will never look daring. But some of your profits will be large; and your losses should be quite small. That is all that is necessary for a satisfactory, enriching investment performance."
What Edgar Genstein is talking about is the core of investment strategy - trend following. While he explains it in an academic sense, I prefer to be more visual.
Picture a beautiful sun setting over the mountains; let's say there are three of them and one is bigger than the other two. Now pretend that you are hiking in these mountains, (not me because I am afraid of heights) and you are scaling the first one; it's not the tallest but you get to the top and the view is nice but you see the second taller mountain. You start to hike down the mountain and then jump across a ravine to the next mountain. It's a steeper climb but you get to the top. The views are stunning until clouds roll in and fog distorts your view. You see that it is clear over on the next mountain so you climb down the steep terrain and take a flying leap across to the next mountain where it is a smoother, easier climb to the top where you reach a flat area where you can get refreshed, rest, eat and prepare for the next part of your journey.
This is the journey of a trend follower. You don't stay on a mountain forever, and you know that you have to go down sometimes to get to the next trend. Climbing mountains can be exciting, but trend following is a very disciplined style of unemotional investing - boring yet effective.
The key with trend following is relativity to the market. You want to ride the trend to beat the market indices. If you put an absolute return goal on your stock investment performance, you will be disappointed most of the time. Following the trends will work in bull and bear markets. Neither lasts forever and the more flexible and realistic you are, the less emotion you will have to enable you to make better decisions. That's why trend following works; it eliminates the emotion in investing and creates the necessary discipline for success.
When you look at a chart on the S&P 500 for the end of 2005, stocks were banging their heads on resistance at a triple top that, yes, does look like a mountain range. It held the market back but eventually broke above it in early January so a longer rally upward could be unfolding here. Watch the trend as the first quarter unfolds and follow it to improve your chances of beating the market.
About the Author
John Lohmeier is President and Chief Investment Officer of Enterprise Trust Co., http://www.EnterpriseAdvisory.com, a Nevada-based trust and investment company. He employs several different quantitative long-short models that follow trends to provide market-beating performance for his clients. He can be reached at 1-877-ENTER01 (1-877-368-3701).
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