Key Takeaways
1. Trend Following: Ride the Waves of Market Momentum
Big money making starts with trends, or waves. Anyone who makes significant money rides waves.
Follow the flow. Trend following is about identifying and capitalizing on market trends, whether up or down. It's not about predicting the future, but about reacting to the present. Think of it like surfing: you don't create the wave, you ride it. The key is to get on board when a trend starts and stay with it until it reverses. This approach allows you to profit from significant market moves, regardless of the underlying reasons.
Agnostic to direction. Trend followers don't care if a market is going up or down; they simply follow the direction of the trend. This flexibility allows them to profit in any market environment. They are not tied to a "buy and hold" mentality, which can be disastrous in bear markets. Instead, they go long when prices are rising and short when prices are falling. This adaptability is a core strength of trend following.
Proven success. The book highlights numerous successful trend followers who have made fortunes by riding market trends. These include names like Bruce Kovner, John W. Henry, and Bill Dunn, among others. Their track records provide concrete evidence that trend following is a viable and profitable strategy. These are not just lucky individuals; they are skilled traders who have mastered the art of following the market's lead.
2. Price is King: The Only Truth in Trading
Price is fact; all else conjecture.
Objective data. Market price is the only objective data point that matters. It reflects all known information, including fundamentals, news, and sentiment. Trend followers don't try to analyze the underlying reasons for price movements; they simply react to the price itself. This approach eliminates the need for subjective interpretations and opinions.
Ignore the noise. Forget the endless stream of news, analysis, and predictions. Focus solely on price action. The market is always right, and price is the only true reality in trading. If the market is going up, you go long; if it's going down, you go short. It's that simple. This focus on price cuts through the noise and allows for clear, unemotional decision-making.
Universal application. Price is the common denominator across all markets. Whether you're trading stocks, bonds, currencies, or commodities, the principles of trend following remain the same. This universality allows trend followers to trade any market, anywhere, as long as price data is available. It's a powerful approach that transcends specific market knowledge.
3. Systematic Rules: Ditch Emotion, Embrace Discipline
We decided that systematic trading was best. Fundamental trading gave me ulcers.
Rules-based approach. Trend following is a systematic approach to trading, meaning it relies on a predefined set of rules. These rules dictate when to enter a trade, how much to risk, and when to exit. This eliminates the need for emotional decision-making, which is a major pitfall for many traders.
No discretion. Once the rules are set, they must be followed without deviation. This requires discipline and the ability to resist the urge to second-guess the system. The system is designed to capture trends, and deviating from it can lead to missed opportunities or unnecessary losses. This is not about being right; it's about being profitable.
Automation is key. Trend following systems can be automated, allowing traders to execute trades without constant monitoring. This frees up time and reduces the risk of emotional interference. Automation also allows for backtesting, which helps to validate the system's effectiveness. This is not about being a robot; it's about using technology to enhance your trading.
4. Trade Everything: Diversification is Your Free Lunch
In order for a trend trading strategy to be accepted it must trade all markets using the same rules. There should be excellent performance for the vast majority of markets.
Broad exposure. Trend followers trade a wide range of markets, including stocks, bonds, currencies, and commodities. This diversification reduces risk and increases the likelihood of capturing significant trends. It's about spreading your bets across multiple opportunities, not putting all your eggs in one basket.
Equal opportunity. Trend following systems are designed to work across all markets, using the same rules. This means that a system that works for stocks should also work for commodities. This universality allows trend followers to be opportunistic, going where the trends are strongest. It's about being a generalist, not a specialist.
Portfolio approach. Trend followers manage their trades as part of a portfolio, not as individual bets. This allows them to balance risk and reward across multiple positions. It's about managing the overall portfolio, not just individual trades. This holistic approach is essential for long-term success.
5. Risk Management: Protect Your Capital, Unleash Your Potential
Return and risk are the two sides of the same coin.
Capital preservation. Risk management is paramount in trend following. The primary goal is to protect capital, not to chase profits. This means using stop-loss orders to limit losses and position sizing to control risk exposure. It's about surviving to trade another day.
Small initial bets. Trend followers start with small positions and gradually increase their exposure as the trend develops. This approach limits potential losses and allows them to capitalize on winning trades. It's about being cautious at the start and aggressive when the trend is in your favor.
Cut losses quickly. Trend followers are quick to cut losses and move on. They don't average down or hold onto losing positions in the hope of a turnaround. They understand that losses are a part of the game, and the key is to minimize their impact. It's about being decisive and unemotional.
6. No Prediction: React, Don't Forecast
You don’t need to know what will happen next in order to profit from whatever happens next.
Reactive approach. Trend following is a reactive strategy, not a predictive one. Trend followers don't try to forecast market direction; they simply react to what the market is doing. This approach is based on the understanding that the future is unknowable. It's about being flexible and adaptable.
Follow the market. Instead of trying to outsmart the market, trend followers follow its lead. They wait for a trend to emerge and then jump on board. This approach is based on the belief that the market is always right. It's about being humble and accepting the market's wisdom.
No crystal ball. Trend followers don't have a crystal ball, and they don't pretend to. They understand that the market is unpredictable, and they focus on managing risk and capitalizing on opportunities as they arise. It's about being realistic and pragmatic.
7. Fundamentals are Religion: Stories Don't Make Money
The system wins. Fundamentals are nice, but useless in trading. True fundamentals are always unknown.
Reject narratives. Trend followers don't rely on fundamental analysis or economic narratives. They understand that these stories are often misleading and can lead to emotional trading decisions. They focus on what they can see, not what they think they know. It's about being objective and data-driven.
Price reflects all. The market price already reflects all known fundamentals. Trying to analyze these factors is a waste of time and energy. Trend followers focus on the price itself, which is the only objective measure of market sentiment. It's about being efficient and focused.
No emotional attachment. Trend followers don't get emotionally attached to their trades or their beliefs about the market. They are willing to change their positions quickly if the market moves against them. It's about being flexible and adaptable.
8. Embrace Change: Adapt or Perish
Markets go up, down, and sideways. They trend. They flow. They surprise.
Markets are dynamic. Markets are constantly changing, and trend followers must be able to adapt to these changes. They don't cling to outdated strategies or beliefs. They are always learning and evolving. It's about being agile and responsive.
Flexibility is key. Trend following systems are designed to be flexible and adaptable. They can be applied to different markets and timeframes. This flexibility allows trend followers to thrive in any market environment. It's about being versatile and resourceful.
No rigidity. Trend followers don't get stuck in their ways. They are always open to new ideas and approaches. They understand that the market is constantly evolving, and they must evolve with it. It's about being open-minded and curious.
9. The Crowd is Wrong: Be a Contrarian
Beware of consensus.
Go against the grain. Trend followers are contrarians. They understand that the crowd is often wrong, and they are willing to go against the prevailing sentiment. This requires courage and independence of thought. It's about being a free thinker and not a follower.
Exploit herd behavior. Trend followers profit from the herd mentality of most market participants. They understand that markets often overshoot their fair value, and they are willing to capitalize on these extremes. It's about being opportunistic and strategic.
Independent thinking. Trend followers don't rely on the opinions of others. They do their own research and make their own decisions. This requires self-reliance and confidence. It's about being an individual and not a sheep.
10. Commitment is Key: The Path to Exceptional Returns
You have to wake up every day with a deep desire to be successful.
Long-term focus. Trend following is not a get-rich-quick scheme. It requires patience, discipline, and a long-term perspective. It's about building wealth over time, not making a quick buck. This is a marathon, not a sprint.
Relentless pursuit. Trend followers are committed to their craft. They are always learning, improving, and refining their systems. They are not afraid of hard work or setbacks. It's about being dedicated and persistent.
Unwavering belief. Trend followers have unwavering belief in their system. They understand that it is not perfect, but they trust that it will deliver results over the long run. This requires confidence and conviction. It's about having faith in your process.
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FAQ
1. What is "Trend Commandments: Trading for Exceptional Returns" by Michael W. Covel about?
- Focus on Trend Following: The book is a comprehensive guide to the philosophy, principles, and practicalities of trend following trading, a systematic approach to profiting from market trends.
- Challenging Conventional Wisdom: Covel critiques traditional investment strategies like buy-and-hold, fundamental analysis, and prediction-based trading, advocating for a rules-based, reactive approach.
- Accessible and Inspirational: Written in an accessible, storytelling style, the book aims to inspire readers to think differently about markets, risk, and wealth-building.
- Real-World Examples: It draws on decades of performance data, interviews with top traders, and historical context to illustrate how trend following works in practice.
2. Why should I read "Trend Commandments" by Michael W. Covel?
- Proven Track Record: The book presents evidence of long-term, exceptional returns achieved by trend following traders, offering an alternative to strategies that often fail during market crises.
- Actionable Philosophy: Covel provides a clear, actionable philosophy for trading and investing that emphasizes discipline, risk management, and adaptability.
- Debunks Myths: It debunks common myths about trading, such as the need for prediction, special talent, or insider knowledge, making success seem more attainable.
- Broad Applicability: The lessons extend beyond trading, offering insights into decision-making, psychology, and personal growth.
3. What are the key takeaways from "Trend Commandments" by Michael W. Covel?
- Follow Trends, Don’t Predict: Success comes from reacting to price movements, not trying to forecast the future.
- Systematic, Rules-Based Approach: Use clear, tested rules for entry, exit, and risk management—discipline trumps intuition or gut feeling.
- Risk Management is Crucial: Limiting losses and letting profits run is central; small losses are inevitable, but big wins pay for them.
- Markets Are Unpredictable: Accept that markets are chaotic and ever-changing; adaptability and agnosticism to market direction are essential.
4. How does trend following work according to "Trend Commandments" by Michael W. Covel?
- Reactive, Not Predictive: Trend following waits for a market to move and then follows that movement, rather than trying to anticipate it.
- Universal Application: The same rules are applied across all markets—stocks, commodities, currencies, etc.—based solely on price data.
- Defined Rules: Traders use specific, systematic rules for when to enter, how much to trade, and when to exit both winning and losing positions.
- Risk and Money Management: Position sizing and risk limits are set in advance, ensuring no single trade can ruin the account.
5. What are the main differences between trend following and traditional investment strategies in "Trend Commandments"?
- No Prediction vs. Forecasting: Trend following does not attempt to predict market direction, unlike fundamental or technical analysts who try to forecast.
- Price Action vs. Fundamentals: Decisions are based on price movements, not on economic indicators, news, or company fundamentals.
- Absolute Returns vs. Benchmarks: Trend followers aim for absolute returns, not just beating a benchmark or index.
- Adaptability vs. Rigid Beliefs: Trend following is designed to adapt to changing markets, while traditional strategies often rely on fixed beliefs or narratives.
6. What are the essential components of a trend following trading system as described by Michael W. Covel?
- Market Selection: Decide which markets to trade, ensuring diversification across asset classes.
- Entry and Exit Rules: Use objective, rule-based criteria (like breakouts or moving averages) to determine when to enter and exit trades.
- Position Sizing: Calculate how much to buy or sell based on account size and market volatility, typically risking a small percentage per trade.
- Risk Management: Employ stop-losses and predefined exit strategies to limit losses and protect capital.
7. How does "Trend Commandments" by Michael W. Covel address risk and drawdowns?
- Embrace Small Losses: Accept that losses are a natural part of trading; the key is to keep them small and manageable.
- Drawdowns Are Inevitable: Even the best trend followers experience periods of losses (drawdowns), but sticking to the system allows recovery when trends reappear.
- Risk Per Trade: Covel recommends risking a small, fixed percentage (often 1-2%) of capital per trade to avoid catastrophic losses.
- Portfolio Risk: Manage not just individual trade risk, but also the total risk across all open positions to avoid excessive exposure.
8. What psychological and behavioral principles are emphasized in "Trend Commandments" by Michael W. Covel?
- Discipline Over Emotion: Success requires following the system regardless of emotions, news, or market noise.
- Emotional Intelligence: Covel argues that EQ (emotional intelligence) is more important than IQ for trading success.
- Avoiding Herd Mentality: Trend followers must be willing to act independently, often going against the crowd.
- Patience and Commitment: Long-term success comes from patience, perseverance, and unwavering commitment to the process.
9. What are some of the most important quotes from "Trend Commandments" and what do they mean?
- "You don’t need to know what will happen next in order to profit from whatever happens next." – Emphasizes reacting to price, not predicting.
- "Limit losses and ride profits, irrespective of all other rules." – The core of risk management and trend following.
- "Markets are never wrong, opinions often are." – Trust price action over personal beliefs or expert opinions.
- "If you don’t know what’s going on, don’t do anything." – Advocates for inaction over impulsive, uninformed decisions.
10. How does "Trend Commandments" by Michael W. Covel critique Wall Street, the media, and conventional financial wisdom?
- Media Distraction: Covel argues that financial media and Wall Street often promote noise, predictions, and stories that mislead investors.
- Conflict of Interest: He highlights how mutual funds and financial institutions profit from keeping investors in the dark or selling hope.
- Benchmark Obsession: The book criticizes the focus on quarterly performance and benchmarks, which can lead to poor long-term decisions.
- Hero Worship: Covel warns against blindly following gurus, experts, or famous investors, advocating for independent thinking.
11. What historical context and real-world examples does "Trend Commandments" provide to support trend following?
- Performance Data: The book presents decades of performance from top trend followers like John W. Henry, Bill Dunn, and David Harding.
- Market Crashes: Covel shows how trend followers profited during major market crashes (e.g., 2008), while most investors lost money.
- Origins of Trend Following: The book traces the roots of trend following back to early traders and the development of systematic methods.
- Case Studies: Real-life stories of traders, both successful and unsuccessful, illustrate the principles and pitfalls of different approaches.
12. How can readers apply the lessons from "Trend Commandments" by Michael W. Covel to their own trading or investing?
- Adopt a Systematic Approach: Develop or use a rules-based trading system that removes emotion and subjectivity from decisions.
- Diversify Broadly: Trade a wide range of markets using the same rules to capture more opportunities and reduce risk.
- Focus on Process, Not Outcome: Prioritize following the process over obsessing about individual trade results or short-term performance.
- Continuous Learning: Stay curious, question conventional wisdom, and be willing to adapt as markets and personal understanding evolve.
Review Summary
Trend Commandments receives mixed reviews, with ratings ranging from 1 to 5 stars. Some readers find it insightful and entertaining, praising its psychological approach to trading and investment strategies. Others criticize it as repetitive, lacking in technical details, or merely a promotional tool for the author's other works. The book is generally viewed as an introduction to trend following and trading psychology rather than a comprehensive guide. While some appreciate its anecdotes and quotes, others find the content shallow or difficult to get through.
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