Saturday, March 07, 2015

If you get a signal - take it!

It is vitally important that a trader has the conviction of his beliefs. It is no good if his method indicates that he should be going long on a stock or an instrument, if he is influenced by others to either not take the trade, or worse still, go short.

This is particularly true of trend following, where often most people tend to dismiss or ignore a price breakout to new highs or lows until the subsequent trend is well established. Witness the downtrend in crude oil in recent months as an example.

Richard Dennis said it best in his Market Wizards interview:

"When we taught our people to trade, I had a hypothetical question: Suppose everything you know about the market indicates a "buy". Then you call the floor and they tell you that I'm selling. Do you: a) buy, b) go short, c) do nothing? If they didn't eventually understand that a) was correct because they have to make their own market decisions, then they didn't fit into the program."

Similarly, there have been lots of traders calling a top in the equity markets for what seems like forever. Yet the markets keep on moving up. Depending on his entry and exit criteria, a trend follower will simply react to what price is telling him. Opinions or predictions are left to others.

It is critical that a trend follower acts on those signals that his method gives him and opens those positions. Successful trend followers will be able to do this. I remember reading a story about a successful trend follower who got a long signal on heating oil in the middle of summer (what???). Despite his initial perceptions or doubts over the trade, he took the signal, which turned into a big winner.

Larry Hite told the story of a trader he knew who had made a fortune in the markets and had developed a trading system which made money:

"One day he said to me "I am not taking the sell signal in gold; it doesn't look right to me. Besides, almost 50 percent of the signals are wrong anyway." Not only didn't he take the sell signal, he actually wound up going long. Sure enough, the market went down. I told him "Get out!" but he insisted, "The market will come back."

Well, he didn't get out, and he lost the mansion and everything else.

He had it and lost it all! And all because of one trade. The irony is that if he had followed his system, he would have made a fortune on that trade."

If your trading approach is based on reacting to price making new highs or lows and acting accordingly, then this is where you need to go onto auto-pilot, calculate your position size, and get in the trade. Worst case scenario is that you will lose a small element of your equity. The potential reward is that could be the one trade which makes your year. Seems like a good odds play to me...

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