Sunday, April 28, 2013

Be objective and simplify

To paraphrase Monty Python, it may be stating 'the bleeding obvious' but trend following is a very simple concept. If a stock or instrument is going up, you go long. If they are going down, you go short. The only differences between trend followers as that they will have their own parameters which determine how early or late they get in and out of a price movement.

So, what is a trend? I describe this as "a general drift or tendency in a historic set of price data. To identify a trend, comparison is made between the current price and a historic price level. If the current reading is higher than the historical reading, we have an uptrend. If lower, we have a downtrend. Traders often look at a series of highs and lows attained over a period of time to determine the trend. A series of higher highs and higher lows signify an uptrend, while a downtrend is identified by a pattern of lower highs and lower lows."

In more basic terms, I'm reminded of what Jack Boyd told Larry Hite, which Hite referred to in his Market Wizards interview:

""Larry, if you want to know where a market is going, all you have to do is this." He threw down his charts on the floor and jumped up on his desk. He said, "Look at it, it will tell you!""

So, when it comes to trading, and trend following in particular, do not overlook the obvious. Price should be the sole metric you refer to - after all it is only if price moves in your favour, or against you, that determines whether you can make a profit or a loss. Everything else is just fluff.

When observing a chart, what is your initial thought? Do you focus objectively on what price is telling you, or do you start putting obstacles in your way - do you worry whether a price movement is overbought or oversold, start worrying about the underlying fundamentals, or start looking around for the opinions of others?

Think of it this way. More often than not, it is my contention that a stock's price movement following an earnings release or trading update is determined not necessarily by the actual results released (which relate to historical performance), but by the buying and selling decisions taken based on the perception about what will happen going forward, their future plans and projections etc. 

Now, how many of us can see into the future? I know I can't, and trend followers en masse do not profess to either. All they do is observe what is happening NOW, and act in an objective manner. It really can be that simple. Refer to this post for an example.

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