How Much Money Can You Make From Trend Following?
One of the most common questions I get from readers is, “How much money can I make with trend following trading strategies?“
… I guess some people just want to cut to the chase!
And hey, I can’t blame ’em. After all, why invest in learning how to find breakout stocks if they aren’t profitable, right?
I get it.
But on the other hand…
There’s a Reason I Haven’t Discussed Trend Following Returns:
Because… at the end of the day… a LOT of people talk crap on the internet.
And discussing investment returns is one of the fastest ways to join the ranks of online exaggerators!
So I’ve purposely avoided talking about the kind of performance you can get from trend following trading.
To make matters worse…
Sharing return information is fraught with misunderstanding (intentional or otherwise).
For example, I could tell you my account grew by 30% last year. Sounds great, right?
But am I measuring from Jan 1st to Dec 31st? … Or… is it some other time period I haven’t disclosed?
And what if I “conveniently forgot” to tell you that 10% of my account growth was due to new deposits.
Or what if I had a huge drawdown along the way, but didn’t disclose that fact to you?
Are returns path dependent?
Trader Rayner Teo also has a great post on this concept. He also provides a helpful reminder the concept of R can help measure trading performance more effectively. So check out what he has to say on this topic too.
Another great example comes from JBMarwood.com, where Joe shares his 2015 Trend Following Performance.
I encourage you to take a look, because this is the kind of robust look you want to see when people are talking about their results – not just ambiguous claims about win % or percentage gain.
My point is…
There are lots of people who use misleading performance numbers to give the appearance of expertise. So…
That’s why I haven’t talked much about how much money you can make from trend following with stocks.
And don’t forget…
Online Trading Gurus Often Underplay The Risk They Take!
Risk/reward is a critical factor in any trade or investment decision. Sure…
Some people MIGHT be able to get massive triple-digit returns one year.
But what risks are they taking to achieve these returns?
And what’s the probability of repeating that success?
In the book Trend Following with Managed Futures, the authors do a great job explaining how trend following can provide superior risk-adjusted returns.
Trend following strategies perform quite well in crisis environments, where you can catch big trends to the downside.
… As for me?
I’m mostly trend following with stocks. So the results are slightly different.
And… while I’ve had some great years in the market… 2015 and early 2016 were particularly tough for the intermediate term trend following models (which is mostly what I trade).
To help you see what I meant, this long-term chart of the SPY ETF does a good job showing the major trends (or lack thereof):
See how flat the market was in 2015? That ‘s a tough environment for trend followers where they’d be lucky to break even.
On the other hand… 2017 has been off to a GREAT start!
And although I’ve traditionally only focused on stocks, I’m starting to diversify into other asset classes using a forex account, and commodity CFDs.
I’m also starting to get more active on the short side to further diversify returns. I’ll keep you posted how this goes, but for now it’s only a token amount of money I’m experimenting with.
In order to give you a better look at the kind of returns you can get from trend following, I want to share some examples of performance records that are a bit more robust.
My hope is that this higher-quality data will give you a better idea of the kind of money you can expect to make with trend following trading strategies.
But first, let’s talk about the patterns of returns you can get from trend following. This big picture understanding helps give you more context than just a headline return number.
What Return Distribution Should You Expect from Trend Following?
Overall, various trend following trading models have a relatively common distribution of returns. That means even if you have some unique facets to your trend following model, the below should still be applicable.
Because even though the underlying asset classes or trading signals might be different, they have a similar strategic underpinning.
“So what do these return patterns look like?”
In theory, if you did 50 trades, you can expect trend following trading models to give you about:
- Lots of small losers, (20-30 trades)
- Lots of small winners, (20-30 trades)
- A couple BIG winners! (3-8 trades)
Even if it sounds good in theory, the trick is that since trend following trading models usually have a success rate of around 40-50%, you can easily have big runs of losing trades.
That’s why you simply MUST keep your losses small!
If you haven’t taken 10 losses in a row before, well, it can be discouraging.
But it doesn’t necessarily mean you have a bad trading system. So you need to keep taking your signals.
The other key factor is those BIG winners.
For example, in my trend following models during a bull market, the average winner is usually around 2.75 – 3.25 times bigger than the average loss.
I can afford to take lots of small losses, because those big winners will often pay for 10 or more of these “experiments.”
And actually, Nick Radge, has done a great job showing this relationship with an expectancy curve, I encourage you to check it out!
In fact, I actually went ahead and made a short video to talk through this important concept!
Therefore… and mathematically speaking… the key is to: (1) keep your losses small, and (2) keep swinging at new signals!
It’s like what Jeff Bezos wrote in his first Amazon shareholder letter, back in 1997:
“Given a 10 percent chance of a 100-times payout, you should take that bet every time.”
I know Jeff Bezos is obviously not a trend follower. But it’s the same idea…
… You take lots of bets.
… You know most will lose.
… And you expect a few will payoff BIG!
Another great example of this comes from Steve, at TheTrendFollower.com. He reveals all his performance statistics.
You’ll see his losses are much smaller than his winners – consistent with the distribution described above.
Now that you have a better understanding of what type of return distribution you can get with trend following trading strategies in general (including diversified multi-asset and multi-market CTAs), let’s look more specifically at how this applies specifically to stocks.
Trading Returns from Trend Following with Stocks:
Beyond anecdotal evidence from great trend following traders, there isn’t a ton of data on what kind of returns you can expect from trend following.
In fact, there’s a lot of contention online that trend following might not work for stocks! What?
Then what are we even doing here?
Well… not so fast…
Because there are other people who make a compelling case that trend following works GREAT on stocks!
So which is it?
I can tell you… in my personal trading experience… I’ve had good luck trend following with stocks, particularly in bull markets.
I like the strategy and have consistently positive returns in-line with what you’d expect.
But don’t take my word for it…
I encourage you to read the paper if you’re interested.
But… (spoiler alert)…
The authors DO conclude there’s strong empirical evidence trend following strategies work on stocks!
… And even better….
Part 2 of this study goes on to suggest that even simple trend following rules can outperform.
The other cool thing these studies point out is that trend following in stocks can ALSO help you avoid vicious bear markets.
This is especially valuable to know if you’re trading individual stocks… because… the fact of the matter is, some stocks DO go bankrupt. So that’s why…
“I LOVE to use simple technical rules to keep me out of downtrends!”
Another good and simple example of this type of trend following in stocks comes from ChartingTrends.com.
The author, Danny, shows a simple Nasdaq trend following model that could outperform by 65%. Not bad, right?
Now by the way…
In my own experience, the distribution of returns from trend following in stocks look very similar to trend following in general. That said…
There are a few specific things you want to be aware of when trend following with stocks.
First of all, earnings are a real risk. And while you may decide to gloss over them as part of your strategy, they are a fact of life in the stock market.
The big risk from earnings releases is that your stocks can gap down WAY below your stop-loss. This is particularly bad for positions that are already in the negative heading into earnings (but have not yet hit your stop-loss).
Personally, I’ve been stung by this before.
This can lead to a much bigger than planned-for loss.
The other thing to keep in mind is the stock market is VERY highly correlated. Of course, you can mitigate this to a good extent by taking shots on the short side.
If you’re a long-only equity investor using trend following strategies, you’ll find your stocks do tend to move in a convoy.
This can sometimes expose you to larger than expected losses at the portfolio level.
I encourage you to think carefully about how much money you can lose…. before…. you start to lose sleep at night!
And as I said, if you play on the short side or add other markets, you can further diversify away risk using these strategies.
On that note…
Let’s quickly look at the kind of money you can make when you’re trend following across different currency or commodity markets….
Multi-Asset Class CTA Trend Following Returns:
Now although I primarily trade only stocks, professional trend following commodity trading advisors can access many more markets. And naturally, this is an advantage.
Diversified CTAs are first and foremost just that… diversified!
Some of them trade hundreds of markets, from common currency pairs to barely-liquid commodities. And hat can definitely have an impact on performance, as it significantly reduces correlation!
Many of these professional trend followers are also diversified across timeframes, which helps them maximize profits by catching trends of different sizes.
Plus, when trading commodities, currencies and other financial instruments, these professional CTAs can get great leverage to really help them maximize their edge.
But you know what?
Even with these advantages trend followers do still struggle in choppy markets!
But trendless markets aside, this kind of trend following can often outperform in bear markets.
Going back to the book Trend Following with Managed Futures, the authors lay out a compelling case for how trend followers provide “Crisis Alpha.”
In case you’re not familiar (emphasis mine):
“Crisis alpha opportunities are profits which are gained by exploiting the persistent trends that occur across markets during times of crisis.“ This study goes into much more detail on this unique strategy.
By the way…
This crisis alpha is why some institutional investors use these trend following as a hedge on their portfolios. And while I’m starting to dabble in this space, I’m also happy to defer to others.
Michael Covel has probably done a better job than anyone in compiling trend following performance records.
Exhibit A is a a century of trend following performance, presented by AQR Capital Management. There’s also a follow up paper with over 200 years of data (if you can believe it!)
Covel has also done a great job compiling long-term performance track records of well-known trend followers, like Jerry Parker of Chesapeake Capital and William Eckhardt. I really encourage you to look at their records, thanks to Covel.
Finally, renowned trend follower Bill Dunn provides another very compelling case study:
“Founded in 1974, DUNN Capital Management is a Commodity Trading Advisor (CTA) with a long, rich history of experience and performance. The DUNN Composite track record spans over 40 years and has produced a compounded annual rate of return of over 19% per annum, after all fees and expenses.”
I mean, pretty good, right?
Well… keep in mind… they have pretty hefty performance fees, too!
And in case you’re not convinced, here’s what that kind of track record looks like beside the S&P-500:
Of course, while this might start to give you a good picture of what trend following returns can look like, there are a few caveats I should share.
Trend Following Performance Varies Across Market Types:
At the end of the day, not all trend following results are created equal. In fact, there are three broad market conditions that you need to be aware of when trend following in stocks.
First of all, trend following definitely works best in bull markets.
When equities are trending higher, you can expect to get impressive returns from trend following strategies. You just ride the wave higher.
Plus… if i’m being honest… trading trend strategies in bull markets is fast, fun and easy. It often only takes a few minutes each day to stay on top of your positions!
But the flip side is…
In sideways markets, where the major market indices are just oscillating in a trading range, trend following strategies don’t work too well.
Instead, your account will likely just get chopped up with many false-breakouts. It hurts. And it’s why you need to keep your losses small. Make sense?
Trend following in bear markets can also work well… as long you’re comfortable on the short side. Just like the upside, you can catch big trends.
Another way to think of it is like Stan Weinstein’s stage analysis model. This image from ChartMill describes this simple methodology:
So… as you can see… trend following can give great returns during stages 2 and 4. But it suffers in stage 1 and 3. Does that make sense?
I hope it’s becoming obvious to you by now… but… the market condition can have a HUGE impact on your trend following results!
That’s also why I’m such a big fan of top down trading, because it can help you understand where you’re at in relation to the big picture. And that can make all the difference.
But there’s one more thing you need to be aware of…
Individual Trading Preferences Influence Results:
At the end of the day, one of the biggest determinants of how much money you can make from trend following comes down to your personal trading preferences.
A great example of this, are the Turtle Traders. These traders were taught how to make money in the markets from trend followers Richard Dennis and William Eckhardt.
For a few years, all of the turtle traders worked together in a room and had relatively similar results as they were all trading the same signal and supposed to be taking similar trades.
A few years later, after the traders went their own ways, there was a huge dispersion in their results. In fact, some of the turtles stopped trading all together.
While on the other hand…
Jerry Parker started Chesapeake Capital, where he now manages billions of dollars for private clients.
So it’s pretty clear: a big variable in determining how much money can be made trend following is how you personally apply the strategies.
At the end of the day…
If you’re willing to bet bigger you’re going to have more potential upside but also more volatile results. And if you bet smaller and play a little more cautiously, you are likely to give up some upside but will have smaller drawdowns.
Now, let’s wrap this up…
Conclusion: How Much Money Do Trend Followers Make?
I know you might be looking for a simple and straightforward number telling you that you can make X% trend following.
But at the end of the day, there are just a few too many variables to do that accurately. On the other hand though, I hope I’ve shown you that there are many people using trend following trading strategies to outperform.
However, depending on your personal style, the asset classes you’re trading and the market types you’re experiencing, your results will vary.
My hope is that this article has explained these different factors and can help you have realistic expectations when using trend following trading strategies.
And by the way…
If you want to see how I put these trend following trading strategies into action myself, you can sign up for my free mini-course below. I’ll send you a 12-page PDF and weekly trend following stock picks to show you how you can take advantage of these trading strategies for yourself. Sound good?