Five-Decision Trend Following System
Predefine the portfolio, entry, size, and both exits before trading
- Difficulty
- Advanced
- Time to result
- ~months to results
- Steps
- 5
- Confidence
- 99%
The system converts trend following into five decisions made before emotion can distort a trade: what markets to include, what price action triggers entry, how much capital to risk, when to exit a winner, and when to exit a loser. Covel argues that the instrument matters less than broad diversification across liquid movers such as commodities, currencies, equity indices, and interest rates. The trader does not forecast direction; movement itself supplies the signal. Position sizing prevents one loss from becoming fatal, while separate winner and loser exits preserve capital and allow profitable trends to run. The payoff resembles venture investing: many small, controlled bets can lose, while one large move pays for the failures.
Origin
Michael Covel presented five rules for thinking about trend following on Masters in Business, connecting them to the rule-based approach used by Richard Dennis's Turtle traders.
Core principles
- 01Use price action instead of forecasts
- 02Diversify across liquid markets
- 03Set risk before entering a position
- 04Accept many small losses to capture an occasional large trend
How to run it
- 1
Build the portfolio
Choose a diversified set of large, liquid markets rather than relying on one instrument or asset class.
Pro tip Include markets capable of moving independently, such as commodities, currencies, rates, and equity indices.
Watch out A one-market implementation removes the diversification Covel treats as essential.
- 2
Define entry
Write the observable price-action condition that forces a position to open. Treat it as a signal, not a forecast of what must happen next.
Watch out Do not substitute an economist's narrative or personal conviction for the signal.
- 3
Size the risk
Choose in advance how much capital can be put at risk on one trade. Keep the amount small enough to survive repeated losses.
Pro tip Express risk as a consistent fraction of available capital.
Watch out Covel warns that betting ten percent repeatedly can quickly exhaust the account.
- 4
Define the winning exit
Set the rule that closes a profitable trade after the trend changes or the system's exit condition appears.
Pro tip Give a large trend enough room to become the winner that pays for smaller losses.
Watch out Taking profits solely because they feel large can cut off the system's asymmetric payoff.
- 5
Define the losing exit
Place a predetermined stop or exit condition that removes the position when it moves against the system.
Watch out Hoping a losing position will recover turns a controlled loss into a threat to survival.
In the wild
Economists see no reason for oil to fall, but the trader has no oil forecast. Oil is already in the diversified portfolio, its price crosses the predefined entry threshold, and the trader opens a position at the predetermined risk size. The trade remains open until either the winning or losing exit rule fires.
→ The trader can participate in an unpredicted move while keeping the possible loss bounded.
A trader spreads small, controlled bets across many markets. Most positions produce small losses, but one sustained trend becomes the equivalent of a breakout film and covers the unsuccessful positions.
→ Portfolio-level asymmetry matters more than being right on every trade.
Common mistakes
Forecasting before following
A directional opinion can cause the trader to ignore the price action that is supposed to trigger the system.
Risking too much per trade
Large position sizes make an ordinary run of losses terminal rather than recoverable.
Trading one market
A single market cannot provide the diversified opportunity set Covel says the method requires.
Is it for you?
Best for
It is best for systematic traders who can diversify and follow predefined rules through losses.
Not ideal for
It is not ideal for anyone seeking certainty, frequent wins, or a discretionary single-market strategy.
From the transcript
“First, what's the portfolio you're going to trade? Trade everything?”
“Number three? How much you're gonna bet? You can't bet unlimited.”
“When do you exit this trade with a winner? When do you exit this trade with the loser?”
From the episode
Interview With Michael Covel: Masters in Business (Audio)
Michael Covel