Here’s How To Define The Trend
Throughout the late ’90s and through 2000,
it was not uncommon for me to make several dozen trades in a given day. But do
not let that fool you. I always traded in control and always traded with the
trend. Over time, I came to realize that each person defines trend based purely
on the way THEY trade. A trader who takes his/her entry cues from a monthly
chart will define trend very differently than will I.
Fast forward to present day (late January 2003), and as we all know, the
markets are very different. First off, we are in a bear market, but more
importantly, the volatility has dropped off dramatically intraday. So for guys
like me, while still very active by most standards, the frequency of my trades
is much lower on any given day.
This brings up a critical point. A few years ago, if you made a few trades
from the hip which did not play out, it was no big deal, there would be several
more winning trades that would make that loss look trivial. Today’s market
allows for no such errors. This market demands perfection. On top of that, there
are far less high-probability setups in any given day, so you had better be
really selective on each trade you take. A couple of losers from impulsive
trades can and will wipe out any gains.
So how do you avoid these types of traps? Naturally, the answer will be in
the context of the time frame that I trade. My average trade may last anywhere
from 2-3 minutes up to 20 minutes. I always, with a few special situation
trades, trade in the direction of the trend. For me it not only makes sense in
terms of the shear statistical evidence, but also from a mental standpoint. I
would much rather have the wind at my back than having it blow in my face. It
simply makes trading a lot less stressful.
First off, trend (for purposes of this article) is not defined by:
- Trend on the daily chart, hourly chart or even the monthly chart
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- The net change on the day
It is, however, defined by the trend in the last 15-20 minutes or even less.Â
I know this may sound very remedial, but it is funny just how many people I
have worked with over the years who make big mistakes by ignoring such a simple
concept. Human nature seems to attract traders to always buck the trend. It is
this notion that picking the bottom or calling the top will lead to some
spectacular gains. While this is true from time to time, in the long run, it is
a losing strategy.
Take a look at the chart below of
General Electric
(
GE |
Quote |
Chart |
News |
PowerRating). I think it is safe to say at this point that it is clearly in an up-trend
as noted by the rising 20-period moving average. Next, notice the two arrows
drawn, Arrow A and Arrow B. The arrows simply indicate the price action at the
end of the previous move up in the last 4-6 bars, or what I would call a
pullback toward the 20-period moving average where the move exhausts itself
and starts back up. Notice anything about the distance between the lines which
denote the top of that move to the bottom where the next thrust starts?
They are less than half the price range on the up
moves. That simple observation alone speaks volumes. You are reducing your
range of possible entries and exits by 50%. In this case, assuming your were
able to sell short right at the top of Arrow B which is $24.70 and cover at the
bottom, $24.59 you would have made 10 cents. But how realistic is that? It is
not. When you take into consideration slippage, it is not difficult to see why
bucking the trend is a fool’s bet.
One other thing to consider is that you do not want
to make determinations of the trend by going to far back in time. The trend can
change in a matter of minutes.
Look at the chart below:
Despite having a ferocious rally up from 11:00 AM
until 11:14 AM and tacking on 7 S&P points, the trend is immediately reversed.
If you continued to view the trend as up and bought some of the pullbacks from
11:30 on, you did not fare too well.
Flexibility and adaptation in a spilt second will pay
you many dividends as a trader.
Keep it simple; trade with the trend.
It looks as though the market is shifting gears yet again this morning. Yesterday’s gains have already been swept aside, so I expect some excellent
setups on the opening. Look for opening reversals on stocks that open lower
than the overall market.
Key Technical
Numbers (futures):
S&Ps |
Nasdaq |
| 888 | 1029 |
| *875-78* | 1020 |
| 865 | *1011* |
| 853 | 996 |
| 842-46 | *979-84* |
| 831 | 965 |
| **820** | 957 |
| Â | 940 |
As always, feel free to send me your comments and
questions.