Thursday, January 24, 2013

Working the line of least resistance

Two big US stocks issued their latest earnings yesterday. One went up, the other went down. Yet looking at the charts may have given you a clue...

Netflix is already on a long signal, and has been in a gentle uptrend for a while, with one or two previous signals being fairly short lived. However, trading in the direction of the trend would have resulted in a nice windfall profit on this morning's open.

Similarly, Apple has been going in only one direction since topping out and reversing at $700 a few months back. The downtrend has been somewhat choppy, with one or two exit signals given during the downtrend, but with subsequent re-entry signals given. Certainly no indicators to go long any time soon...Again, trading in the direction of the trend here would have resulted in profits.

Some traders I know trade the trends but have specific rules dealing with liquidation of their positions prior to earnings announcements. Others I know trade the trend regardless of any impending news. One trader I know held Apple during the profitable uptrend early last year. He got in near the breakout at $400 and held well into the $600's. In a conversation I mentioned that he had held through earnings - his response was "Did I? I didn't know that!". He is an experienced trader and was staying faithful to his system, which identified trends, ignored news and stayed in his positions until the trends finished. Horses for courses...

Just as an alternative I've shown the same two stocks with a 50EMA instead, which can give rise to longer term trends. The point here is that trading in the direction of the trend (however you define it) more often than not pays, along with avoiding overbought/oversold indicators like the plague:



Of course, it is quite possible that Neflix could have gone down and Apple could have gone up. On a sample size of one, it's a 50:50 shot. But, over the long run, trading in the direction of the prevailing trend, or, as Jesse Livermore called it 'trading along the line of least resistance' works more often than not.

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