Trend Following - A trader's systematic approach to profits
Learning from the masters series
In my journey to learn more about investing, I have started reading up and listening to many of the veterans in the business who have made their fortunes in quantitative, systematic, technical trading and also in long-term investing.
Today, I will delve into the learnings from Larry Tentarelli. He is the Chief Technical Strategist and Founder, Blue Chip Daily Trend Report and a technical prop reader himself.
Larry Tentarelli's Background and Trading Evolution:
Larry started trading in 1998, growing up fascinated by the stock brokerage business due to family involvement.
Initially focused on fundamental analysis (e.g., Warren Buffett, Peter Lynch) but transitioned to technical analysis, particularly after reading Jack Schwager's Market Wizards book.
Struggled for the first 10 years, noting it was a "developmental phase" due to a "conglomeration of different types of styles and time frames".
Discovered trend following after reading Jesse Livermore's "Reminiscences of a Stock Operator," which taught him to focus on catching "the key move" rather than every single market fluctuation, and Michael Covel's "Trend Following," which introduced him to systematic trading without fundamental analysis or prediction.
Began with a simple 20/120 moving average crossover system in 2007, but found it "lagging on the exit" and later stopped using it.
Trading Style and Systems:
Larry uses reactive technical analysis, waiting for price action rather than predicting.
His trades are generally longer term, often holding winning positions for a year or two.
He does not use fundamental analysis or traditional technical analysis (e.g., chart formations, Elliott Wave).
He employs three distinct trading programs/systems, each managed in a separate account to ensure independence and avoid micromanaging positions:
Daily Close Over 200-Day Moving Average: A basic entry for longer-term trades, requiring only price above the 200-day MA.
Breakout to a New 52-Week High: Another simple entry that is easy to scan for.
Momentum-Based Pullback Strategy: Shorter term (60-90 days for him), involving an oversold pullback into a rising key long-term moving average (50, 100, or 200-day) with a full stochastic momentum filter.
He filters stocks by market cap (over $2 billion) and average daily volume (over 1 million shares) to focus on more liquid institutional names. He also filters for higher beta industries.
The Four Legs of Trading:
Larry views trading as having four essential components: entries, exits, position sizing, and proper psychology.
He states that if any one "leg" is removed, the "table still isn't going to work".
Emphasis on Entries (and what's more important):
While entries are important (he assigns them 25% of the overall equation), Larry stresses that traders put "way too much emphasis on only the entries".
He learned that the entry signal is maybe 10% of the equation and not the key to riches; experiments (like Tom Basso's random entry) showed profitability with correct position sizing and money management make more of a difference.
Instead, success comes from a program conducive to one's personality, efficient execution, learning to undertrade, proper position sizing, and effective risk controls.
Exit Strategies and Management of Winners:
People struggle most with overtrading and managing their winners properly.
Larry's approach is predetermined: entries, exits, position sizing, and risk are all established beforehand to avoid emotional decisions "in the heat of the moment".
Exits are primarily based on moving averages, mirroring the entry signal. For instance, if an entry is a daily close over the 200-day MA, the exit signal would be a close below it.
He uses a two-step exit system (e.g., taking half the profit when a stock breaks below the 50-day moving average), which has helped reduce portfolio volatility.
He emphasises the importance of getting comfortable with letting winners run, even amidst volatility, by observing how much profit was lost by exiting too early.
He does not micromanage trades or frequently add to positions, finding that the "first trade is the best trade".
For parabolic moves, if the Average True Range (ATR) doubles within a short period (e.g., 30 days), he cuts the position size in half to manage increased risk.
Position Sizing and Risk Control:
Larry is meticulous and conservative with position sizing, risking 25 to 50 basis points (0.25% to 0.50%) per stock position.
Smaller position sizing helps him remain detached from the outcome of any single trade.
He uses a 2 ATR stop for his core 200-day moving average program.
He embraces volatility in stocks, believing traders need it to make money, but manages the associated higher risk through position sizing.
He does not use margin.
Trading Psychology – The Most Important Ingredient:
Larry believes psychology is the most important aspect of trading.
He learned from Jesse Livermore that "markets don't beat traders but traders beat themselves," and from Alexander Elder that "the weakest link in any trading system is always the trader".
A key insight is to "turn their brains off" and stop trying to predict the markets or rely on news, earnings, or fundamental analysis. He states, "nobody can consistently call the markets and can consistently predict the future".
The biggest lesson learned is to be introspective and accountable, realising that "it's all you" and not to blame the market or external factors.
Handling Drawdowns:
During prolonged drawdowns, he naturally trades smaller due to his position sizing being based on equity.
His two-step exit system also helps reduce volatility during these periods.
Recommended Books:
"Reminiscences of a Stock Operator" by Jesse Livermore.
"Trend Following" by Michael Covel.
"Trade Your Way to Financial Freedom" by Van Tharp.
"The Market Wizards" by Jack Schwager.
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