Is the Trend Really Your Friend?
|The golden rule in conventional trading books is that you must trade in the direction of the prevailing trend in order to be successful. These same books also tell you that the biggest no-no is trying to pick tops and bottoms. On the surface it seems like pretty reasonable advice, however, there are different ways to trade the trend; and if you are skilled enough, picking tops and bottoms should be feasible. In this article we will explore alternative, low-risk entries, that will allow us to join the market trend and not fall prey to the high risk way of looking at the trend.
Conventional technical analysis teaches that one must always wait for trend confirmation. This can mean a trend line that can be connected at three points, or a moving average sloping higher confirming an uptrend. Price confirmation of trend can also be used by simply identifying a series of higher highs or lower lows. This is all text book stuff that most of you already know, so why am I going over it, you might be asking. The answer is that although we might be able to use these tactics, the fact is that if we utilize them in the wrong manner we will end up taking high risk trades, which will result in us losing more of our hard earned money more often than not.
The reality is that market trends are formed by saw-tooth type patterns, not straight forty-five degree angle lines. These undulations tend to trap trend traders because they wait for too much confirmation before they engage the trend. The most likely reason this happens is because of how traders are conditioned to trade trending type markets.
An example this thinking flawed thinking would be, when a market is trending higher it’s safer to buy when it makes a higher peak. Conversely, lots of traders are trained by many conventional trading books to sell only when the market breaks to a new low. As we can see in the chart below, when the market is trending higher, most of the new peaks are followed by counter-trend moves otherwise known as corrections. Therein lies the problem when buying after the new high price has printed, that is unless you’re willing to sit through big draw-downs waiting for the trend to resume.
Likewise, in a downtrend, when the market breaks to new lows, an upward move ensues. This is illustrated in the 60 minute chart of the British Pound Futures contract shown below. Traders waiting for a break in price before shorting will encounter the same difficulty.
As stated before, in order to engage the market trend in a lower risk manner, we have to utilize a different tact than the conventional thinking espoused by the trading books. A lower risk approach to joining the trend would be to wait for the counter-trend moves into quality supply in order to sell short when in a downtrend and buy pullbacks into quality demand when the market is in an uptrend. When I refer to quality levels, I mean levels that score high using our odds enhancers.
The bottom line is that trend following done in a low risk strategy format can be rewarding. In addition, have a set of specific criteria to define the time-frame in which you define the trend. The next step, and by far the most important, is to anticipate when the market trend will change. This is because, by the time everyone has figured out that it’s a trend, it’s just about then, that the market will pullback or change its trend.
Until next time, I hope everyone has a fabulous week.
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