The benefits of trend trading
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By :
Mike Estrey
Submitted
2007-11-10 00:00:00 |
One of the great themes of investment, whether it is stockmarket, commodity, foreign exchange or indeed any financial instrument, is whether or not what you are trading is in a clear trend. The reason this is so important is that trading a trend creates much bigger opportunities than trying to second guess moves within a trading range.
The problem is that for certain instruments, trends do not occur very often. Indeed for some shares, a clear trend is in place perhaps for less than 30% of the time.
Looking for the extra returns
Depending on what you read and your own observation of charts or other analysis, there are times when it is hard to decide if what you want to trade is in a trend or trading a range.
As a starting point for CFD trading, this distinction is absolutely crucial because many popular indicators that are used throughout all market conditions simply don’t work all the time. These indicators are of course used as predictive tools, so it is essential to know when they are useful and when they are not.
As with fundamental analysis, you have to look deeper under the surface if you want the extra returns. It is plainly dangerous to rely on dividend yields, p/e ratios, sales to market capitalisation ratios etc., as stand alone reasons to buy a share on a valuation view.
Likewise it is foolhardy to simply use RSI crossovers, MACDs or stochastics and so on without a thorough assessment of the merits of each within a certain type of market.
This paper is not designed to tell you which indicator works and when, because the answer is ‘some of them do’ and ‘some of the time’. The aim here is to impress on you the need to look for trading opportunities in a detached manner with the information that is in front of you, and then make a trade using a defined set of rules. One of which is simply: “go with the trend”.
Relying on one indicator
Many newer investors tend to find one technical indicator that they feel comfortable with, and stick with it during all market conditions. From a very long term point of view, this approach may have some validity, but in the short term, indicators tend to ebb and flow in their edge over other approaches.
You can of course use indicators to highlight certain set ups, but bear in mind there are millions of people around the world who can tap into any number of free financial websites giving every conceivable indicator.
You may be part of a big crowd with the same information but it is the ability to sift that information that gives the best opportunities. A computer can do this very fast and you actually do not need indicators, although they of course have their uses (see our various other papers).
The reason is that chaos theory tends to negate the benefits of an initial edge – the more people that know about something that works, the more influence that has on pricing to the point where it negates the original benefit. This is standard human nature, even though the cycle no doubt returns in due course.
What is more, there is a school of thought that believes that if you gave a trader a proven system that worked over time, together with the suggested entry points and trading methodology, they would never do as well as the system. Why? Because humans recoil from events outside the norm, and you can be guaranteed that at some stage they will not take all the signals. So we return to going with the trend, and this will focus the mind.
Benefits of finding a trend
The best 90% of market returns are made only 10% of the time, and those usually happen when there is a clear and major trend in place. It is therefore essential to isolate markets, currencies, commodities or whatever is ‘hot’ and ensure that you are participating where you can as a trader only in these issues.
If a share price oscillates but ends up the same price as when you first started watching it, it’s not easy to win consistently, and win a lot. But if you are focussing your trades on stocks or markets with a clear and strong trend, it is possible to ride any number of profitable trends, and win consistently over time.
How many times have you looked at something that appears ludicrously expensive and looked for a short trade when the trend was clearly up? Not only are you missing the big, big uptrend, but you will be emotionally worn out when the downtrend returns.
So, stand back and look at your charts from a distance – does it look as though it’s going up or down? – if you’re not sure, it’s not in a trend.
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Author Resource:-
About the Author:
Mike Estrey is the Head of Research for Blue Index, the Online CFD Trading Specialists. A free 15 day trial of their CFD Research is available, along with CFD Trading Seminars and Workshops.
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