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The Importance of Trend Following in Stock Market Investing
by John Lohmeier
Published on this site: March 29th, 2006 - See
more articles from this month
"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.
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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