A Few Notes on The Trend Following Bible

December 20, 2012 • Posted in Momentum Investing, Technical Trading

Andrew Abraham, founder of Abraham Investment Management, introduces his 2012 book, The Trend Following Bible: How Professional Traders Compound Wealth and Manage Risk, by stating: “I want to teach you to think like a successful trend follower. I am giving you exactly the methodologies I have used on a daily basis for the last 18 years. They are not any magical holy grail; rather, they are robust ideas that give you the ability to make low-risk trades and try to catch trends when they are present.” Using examples based on his trading experience and the results for other trend followers, he concludes that:

From Chapter 1, “Get a Savvy Start” (Page 23): “You have to have the drive, dedication, discipline, patience, and passion to give yourself the potential for success in trading.”

From Chapter 2, “Getting the Most Out of This Method” (Page 34): “…follow the trend. Let profits run without any fear or greed. Simply detach yourself, see what is happening, and follow the exact plan.”

From Chapter 3, “Why Trend Following?” (Page 35): “Trend following is natural and not that complicated. …But it is not simple due to our mental baggage such as fear, greed and ego.”

From Chapter 4, “How Successful Trend Followers Trade” (Page 79): “Trend following success can only happen if you trade only in the direction of the trend. There is no second guessing or debating. You do not let your opinions get in the way. You have an exact plan to follow trades that are working as well as an exact plan to exit quickly trades that are not working. …Buy when the market is going up and sell when the market is going down if you can put on a low-risk bet. No one can ever tell when a trend starts and stops.”

From Chapter 5, “Managing the Risks When Trend Following” (Page 92): “…even though I have risk per trade, risk per sector, open trade equity risk, and margin to equity, I look to cap my number of positions both long and short.”

From Chapter 6, “Your Complete Robust Trading Plan” (Pages 96-102): “Step 1 is about identifying the strongest and weakest markets. …In Step 2, you confirm the breakout risk [for a buy, X-day high minus Y-day low (X>Y); or, for a sell, Y-day high minus X-day low (X>Y)] is not more than 1 percent of your core account size… Step 3 is about trading only in the direction of the MACD. …If the trade starts working, meaning it starts moving away from my initial hard stop, then the next following or trailing stop kicks in…”

From Chapter 8, “Trend Retracements” (Pages 127-128): “The basis is that if you are looking for a long trade, you want to see that on the higher time frame it is trending positively, yet on the lower time frame there is a pullback and slight downtrend. …As we do not know if the trend is reversing or retracing, we want to be pulled into the trade if it starts retracing back in the direction of the trend as identified on the higher time frame.”

From Chapter 9, “The Trend Follower Mindset” (Pages 141, 155): “Your money will be made over a series of trades. No single trade means anything. No month or any year means anything. …There is no fear, greed, boredom, or even having fun. Trend followers with a plan ‘Just Do It,’ trend followers focus on execution. …They are consistent.

From Chapter 10, “My Trading Journal” (Page 192): “…there are numerous small losses and small profits. There are times I stumbled into some big profits, but…they are rare. The diary of my trades dispels the notion that trading is easy by a long shot. The diary shows how missing one trade can be devastating.”

In summary, traders may discover interesting ideas from exploring the very specific and integrated trading/risk management rules described in The Trend Following Bible.

Cautions regarding arguments/findings include:

  • The author mostly uses anecdotes and examples, rather than statistical tests, to support assertions. The general proposition of long-term profitability would be difficult to confirm via backtesting because of the complexity of aggregated rules. Aggregate complexity also invites data snooping bias in specification of parameters.
  • The (successful) trend following traders cited in the book may not reflect the experiences of all professional trend following traders. In other words, the sample may have material selection/survivorship bias.
  • When “no month or year means anything,” testing a system generally requires many years of data (perhaps more than a trading career).
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