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A Guide to Creating A Successful Algorithmic Trading Strategy by Perry J. Kaufman

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CHAPTER 6 If You’re a Trend Follower, Don’t Use Profit-Taking or Stops

What? Don’t use stops? Don’t take profits? How can I control risk? Why wouldn’t I take a windfall profit? It does sound counterintuitive, but it’s really simple to explain. Profit-taking and stops fight with a trend-following strategy.

Let’s consider how trend following works. First, there are long-term trends that hinge on interest rate policy, which is slow moving. Very slow moving. The movement of a Central Bank makes a snail look fast. And, once it has decided on a policy, it implements it tenaciously, slowly, over and over, until it thinks it has accomplished its goal, whatever that was. All that causes trends in the interest rate markets to move slowly and last a long time. In the United States, we could say that this generation of young financial geniuses has never seen a bear market in rates. Yields have been declining, more or less, since 1980. The Eurodollar chart, Figure 6.1, shows that.

Graph with vertical axis ranging 50-110, horizontal axis ranging 12/9/1981 to 12/9/2013 has ascending curve starting above 60, ending at 100.

FIGURE 6.1 Eurodollar Prices from Back-Adjusted Futures

Consider our current situation. The U.S. economy is strong, the European economy is weak. The European Central Bank has just begun quantitative easing (you would think they would have done this sooner to be preemptive). This means money will flow out of Europe, which has lower interest rates, and into the United States. That money will move into U.S. ...

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