The Discomfort Is Load-Bearing
Why the trades I most want to avoid can be part of the payoff I’m after
Previous: Episode 9, You Are What the System Is Filtering
Next: Episode 11, The View From Inside, The View From Outside
The next signal always looks ordinary.
After six months of failed breakouts, I’d like the one that matters to look a little different. A cleaner move, perhaps. Some reason to believe this time will be worth the trouble. Instead, there’s a market that has moved far enough to meet my entry rule, just as the last few did.
In Episode 9’s example, the account was already down about 12 per cent on trades that had been closed. I know how easy it is, looking at a chart later, to say I’d have taken the signal that began the big move. Sitting there with the losses already booked, I might be thinking about how much better I’d feel if I sat this one out.
The trade I’d rather skip
Suppose I take the signal. The trade goes well for a while, then gives back some of its gain. Now I have a different problem. After months of losses, there’s money on the screen I could keep by closing the trade today. My exit rule says to stay in.
The trade might reverse and take back the rest. It might also resume its climb and keep going for months. At that moment, both are possible. If I get out every time a profit feels too good to give back, I may collect more modest gains. I may also cut short the few trades that do most of the work.
In a sample of 10,000 trades from my own research, unusually large winners made up about 5.1 per cent of the trades and contributed roughly 65 per cent of total profits. That’s a result from one sample. What it shows is how much a change to the exits can matter if it touches a relatively small number of trades.
Researchers have examined a related feature of trend following: some strategies can earn disproportionately more from large, sustained moves. [1] For my own rules, the question is whether those gains pay for the failed attempts and trading costs across the full record. A chart of the best trade I ever took can’t answer that.
The timing makes this hard. The losses are already in the account. The trade that might pay for them is still an ordinary signal, or a winner giving back some of its gain. I have to make a decision before I know which story I’m in.
What experience changes
I’ve become better at noticing when I’m about to make an exception. I can hear it in the way I put the question to myself: What’s the harm in waiting one more day?
Sometimes waiting might help. I could test an entry that comes a day later and see whether it avoids enough failed breakouts to make up for the extra cost or the moves it misses. A tighter exit deserves the same treatment. I want to see what it saves on trades that fail and what it gives away on trades that go much further. The comparison has to include both.
Experience helps me distinguish an idea worth testing from a change I want to make because I’m tired of losing. It also helps me spot problems I can fix: a bad price in the data, an order entered at the wrong size, a market that has become more expensive to trade. I can get better at all of that. The next signal can still lose.
There’s a reason I write down what I expect before a difficult period arrives. I want to know how long earlier losing stretches lasted, how much the largest trades contributed, and whether several markets tended to lose together. Months later, when another strategy is doing well and mine has gone nowhere, I can return to the reasons I chose this one. I can also see where the current experience differs from what I prepared for.
When the discomfort is a warning
A rough stretch can be part of the strategy. It can also reveal that I’m trading too large, that fills have deteriorated, or that a relationship the strategy relied on has changed. The feeling is real in all those cases. I still have to find out what’s causing it.
Before I trade a strategy, I look at its historical losses and consider what would happen if they were deeper or lasted longer. That helps me decide how much capital to commit and how much to keep in reserve. The worst loss in the backtest is a reference point. Live trading can go beyond it, and staying within it doesn’t excuse me from checking what’s happening.
My Cut-Back Rule is one decision I make ahead of time. It reduces exposure under specified conditions, using the account balance after gains and losses have been realised on closed trades. I can test the rule as part of the strategy and see both sides of the trade-off: how much it saves when losses continue, and what it may cost if a recovery begins while I’m trading smaller.
If the money available to me changes, I may also need to reduce exposure for that reason. The second manager in Episode 9 had less capital after an investor withdrew money. Asking that manager to show more resolve wouldn’t put the money back in the account.
A course I can still hold
The sailor in the photograph has to carry enough sail to make progress and pay attention to what the boat can bear. Rough water is part of the passage. A leak still needs fixing.
When the next signal comes, I can check the data, the order and the exposure. I can decide whether the evidence still supports the rules and whether the account can carry them. If those checks give me reason to change course, I should. Sometimes they give me every reason to take the trade, and I still wish I could wait until I knew how it would turn out.
That is the discomfort I mean. The same choices that leave me open to another failed attempt can leave me in a trade long enough for an exceptional move to matter.
The pain is not the price of doing it badly. It is part of the price of doing it at all.
Episode 11 looks at that decision from two places: at the desk, while the outcome is still unknown, and later, with the full record in view.
Previous: Episode 9, You Are What the System Is Filtering
Next: Episode 11, The View From Inside, The View From Outside
Sources and notes
[1] Tung-Lam Dao, Trung-Tu Nguyen, Cyril Deremble, Yves Lempérière, Jean-Philippe Bouchaud and Marc Potters, Tail protection for long investors: Trend convexity at work (2016). The paper examines how the payoffs of specified trend strategies respond to large market moves. The figures from my 10,000-trade sample are separate from that research.
Richard Brennan writes on systematic trading, complex adaptive markets, and the philosophical foundations of trend following at atstradingsolutions.com. His published books include The Fractals of Finance, Complex Adaptive Markets, Carved by Impossibility, and The Aussie Turtles Trend Following Guide, co-authored with Adam Havryliv. His forthcoming book, The Trend Following Manifesto, co-authored with Niels Kaastrup-Larsen, is coming soon.
You do not need to predict the future. You need a process that keeps you present for the rare moves that matter.
The Trend Following Manifesto: Building Robust Portfolios for an Uncertain World
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