The Trend Following Bible: How Professional Traders Compound Wealth and Manage Risk

CHAPTER 5

Managing the Risks when Trend Following

The only certainty in trend following is uncertainty. Due to this constant uncertainty it is imperative to manage the risks. We are surrounded by risks. Successful trend followers know that we do not know the future. Given the fact that we are dealing in uncertainty, we have no choice but to be extremely adamant in our risk and money management approach.

Larry Hite, a famous successful trend follower from the 1980s, put it very simply: Trend followers make bets when they trade. If you lose all of your chips, you can't bet!

In other words, you are out of business!

Many successful hedge funds teach their interns how to play poker. I invested in Green Light Hedge Fund with David Einhorn many years ago via a fund of funds that I was involved with. I was fortunate to meet David and learned another one of his talents besides trading was poker playing. David is not a gambler; however, he would make low-risk bets both in his trading and when he played poker. In 2006, Einhorn finished 18th in the World Series of Poker main event. Contrary to what some say, successful trend followers are risk adverse.

Trend followers are not cowboys. Every aspect of their trade is calculated with a well-thought-out exact plan. There is no second guessing. Every possibly outcome has been taken into account.

Risk of Ruin

The concept of risk of ruin tackles the ...