Friday, November 30, 2012

Seeing what you want to see

When a position starts to go against you, it is very tempting to try and 'interpret' a chart in a manner that verifies keeping the trade open.  This is where traders try to use indicators as a 'crux' to justify keeping hold of their position - "I'm long, yet price is going down, but the RSI is saying it's oversold, so I'm okay" - that sort of thing.

As I have mentioned many times on here, I do not rely on indicators other than a very simple trend filter, which is incorporated in my scans. In particular I place no reliance on indicators to determine price targets - a pure trend following system does not use any targets, as they potentially can limit any profits generated from a pronounced trend.

Trend following is an extremely objective way of trading - price is the sole criteria, and is either in an uptrend, downtrend or not trending. The timeframe you use will determine what the current state is - on a hourly timeframe, the trend may be down, yet on the daily or weekly timeframe, the trend may be up. In addition, the price channels used which are an integral part of the system tell me when a potential new trend is starting, signalling a possible entry point, as well as telling me when the trend is finishing, and therefore telling me where to exit.

There is no switching of timeframes to justify keeping an existing position open, or using or manipulating of indicators such as moving averages, RSI or stochastics, or changing price channel parameters to avoid taking a loss on a position. If you use such a rule-based, systematic approach, then overriding or manipulating the rules (especially when you are already in a position) goes against using a rule based system! Using the trend following approach that I do means I am totally consistent in how I trade, with no temptation to see what I want to see. If price is going against, then you were wrong on that particular trade - you exit the position, treat the loss as a cost of business, and move on.

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