The Darvas System is a trend following system. As trend followers, we know we can make big money during Uptrends and big money during Downtrends. Sounds simple enough.
But then, there are Neutral Trends.
Neutral Trends are those tricky “consolidation” periods between Uptrends and Downtrends. They are a necessary part of the market’s ongoing cycle as they give quality stocks the opportunity to form new sound bases and they allow the general market time to digest recent up (or down) moves before continuing in the same direction or reversing course.
Neutral Trends are a constructive and necessary part of trend following. They usually represent the “calm” before the storm. The lull before the next big trend, when the big money can be made.
The most frustrating Neutral Trends are those that are exceptionally choppy. This past year, we saw several of those choppy market periods.
The good news is that these choppy periods always come to an end. Eventually. The trend follower must be patient and disciplined as they wait for that new trend to emerge.
As an example of trend following in action, let’s take a quick look back at 2014.
I’ve put together a very simple back test based on the Darvas Trader PRO Market Health Report from last year. In each issue of DTP, this Market Health Report identifies the market as being in an Uptrend, Neutral Trend, or Downtrend. To keep this back-test simple, I’ve used the Market Health Report to determine a “green light” or “red light” trading environment. If the market was listed as Uptrend or Neutral Trend, we would consider it a “green light” environment and would hold TQQQ, an ETF that tracks the NASDAQ 100 at 300%. If the market shifted into a Downtrend, we would exit TQQQ and enter QID, an ETF that tracks the inverse of the NASDAQ 100 at 200%.
Why use an ETF leveraged at 300% for green light markets and one that is leveraged at 200% for red light environments? Simply because the market has a historic bias towards moving higher.
Again, to simplify this test, I treated Uptrends and Neutral Trends the same. (That is, no trade would be made if the market shifted from Uptrend to Neutral Trend or Neutral Trend to Uptrend.)
Here are the trades that would’ve been made in 2014 based on this method:
– Shift to Downtrend on 2/3/14: Sell TQQQ at $56.36 for a 71.62% gain from the position entered on 6/28/13 (when the market last shifted out of a Downtrend according to Darvas Trader PRO). Buy QID at $63.19.
– Shift to Neutral Trend on 2/10/14: Sell QID at $60.10 for a 4.89% loss. Buy TQQQ at $60.21.
– Shift to Downtrend on 3/27/14: Sell TQQQ at $60.70 for a 0.81% gain. Buy QID at $59.15.
– Shift to Uptrend on 4/1/14: Sell QID at $57.72 for a 2.42% loss. Buy TQQQ at $62.81.
– Shift to Downtrend on 4/7/14. Sell TQQQ at $58.02 for a 7.63% loss. Buy QID at $60.58.
– Shift to Neutral Trend on 5/12/14: Sell QID at $58.36 for a 3.66% loss. Buy TQQQ at $59.95.
– Shift to Downtrend on 9/29/14: Sell TQQQ at $84.13 for a 40.33% gain. Buy QID at $45.30.
– Shift to Neutral Trend on 10/8/14: Sell QID at $44.49 for a 1.79% loss. Buy TQQQ at $85.33.
– Shift to Downtrend on 10/13/14: Sell TQQQ at $74.70 for an 12.46% loss. Buy QID at $46.21.
– Shift to Neutral Trend on 10/21/14: Sell QID at $47.01 for a 1.73% gain. Buy TQQQ at $77.49.
– End of year: Sell TQQQ at $97.45 (the 12/31/14 close) for a 25.76% gain.
What are the key takeaways from this simple little back test?
One, a trader would have done very well with this simple strategy, scoring a 107.40% gain from the 6/28/13 trend start (this quick hypothetical test did not include commission and slippage costs, of course).
Two, most of those gains would’ve come from just three trades, which resulted in gains of 71.62%, 40.33%, and 25.76%.
Three, the other eight trades were in choppy markets and resulted in much smaller gains or losses. And of those smaller gains and losses, they almost always occurred in bunched-together moments before the market finally shifted into an extended trend.
Four, and most importantly, traders who were impatient, frustrated, or undisciplined would have left the market right after a string of choppy moves that resulted in small gains or losses. If they did that, they would have missed out on the biggest winners.
The point is this. When it comes to trend trading, you can make a lot of money even during long market periods that look choppy in hindsight. But to do so, you’ve got to be smart and patient during those choppy market environments. They WILL give way to a new trend…it’s only a matter of time.
* If you’d like to follow this Trend Trading method, I invite you to try out my trading newsletter and coaching program here. Each issue of Darvas Trader PRO includes the “Follow the Trend” ETF trade described above, and an updated portfolio and watchlist of current Darvas Stocks – with EXACT buy points and sell points. Start your 30-DAY TRIAL to Darvas Trader PRO right now and instantly receive my FREE trading course by clicking here.