Saturday, March 05, 2016

Not 'jumping off' the ride, and letting trades play themselves out

A trend follower never takes positions based on predictions or opinions about what may happen. Trend following is reactionary, and based on what price is doing - therefore price has to show some strength before you look to go long, or some weakness before you look to go short.

Just as importantly, trend followers never try and predict potential turning points in a market. There is a process where price can look to change trend from one direction to another - this can happen very quickly, or in some cases take several months! Generally speaking though, this takes time, and a single day's movement does not constitute a change of trend.

It is for this reason that trend followers never get out of an existing position at the extreme of the move. There is always a process of 'giving back' some of the open profits before an exit signal is triggered, and/or a change of trend is signalled.

This is difficult to accept for a lot of people, who try to be 'smart' and predict where the top or bottom of a market will be. The danger however is that trying to identify the end of an existing move can lead to lost profits. A one day move against the trend may tempt some into exiting the trade, and for a few days at least, they may look as if they are correct. But, in a week or two's time, the trend they were attempting to follow may have re-asserted itself. If that happens, those same traders are now left on the sidelines as price starts to accelerate away from where they 'jumped off' the ride.

Over the last few days I have seen plenty of traders who are saying that the recent move up in the markets may be coming to an end, momentum is running out, they are overbought, and that they are looking for entry points to exit and may be even go short. 

Before you do that, just ask yourself some questions:
  • What is price doing now?
  • Which direction is it moving?
  • Based on your chosen timeframe and parameters, which direction should you be trading in?
  • Before you think about exiting a current trade (perhaps trying to pick the top of the recent move up) have you been given an exit signal?
  • Before you think about initiating a new short trade, have your entry criteria been met?
The first two points are crucial for a trend follower. They will look at where price has been, and the direction where it is current going. They do not know what will happen in the future, but they DO know that trends, once established, have a tendency to persist. How long will a trend last? No-one knows. All they know is that a price trend will continue until it doesn't.

Being able to accept that is a major part of a successful trend follower's mindset. He will know that he will lose more often than he will win. He will know that often he will only get a small profit on a trade. He will also know, though, that once in a while you can get into a trade that will yield a major trend, and therefore a major profit.

As a rule, trend followers do not use price targets. They never say that price has moved 'far enough'. The best trend followers never want to be accused of potentially cutting their winning trades short. They will let them run as long and as far as they can. You never know when a major trend may be starting. Occasionally, a trade which has moved into a small profit may turn into a scratch trade or even a small loss. You can never know what will happen. However, it is true to say that all big profits (and trends) start out as small profits. Your job is to stay on that trend as long as your own parameters and rules allow, until a stop is triggered.

Depending on these parameters and chosen timeframe, you may currently be trying to embrace the volatility while holding onto short position that you may have opened around the turn of the year. Alternatively, you may be holding some long trades that you have recently opened. What is right for you may be wrong for someone else.

Currently, I hold three positions that have been opened over the last ten days or so (two stocks, one commodity). All of these are on the long side. Now, I will hold these as long as my stops are not hit. I will not be trying to time the top of the current price move in those instruments. I will simply let the trades play themselves out. 

Once I am in a trade, generally the only price level that concerns me is my stop level. As a trade progresses, then a trailing stop can be employed to 'lock in' profits as price continues to trend. Anything else that happens is pure noise as far as I'm concerned. I cannot control what price does, but I can control my actions - such as where to place my stops, and making sure I don't snatch profits for fear of losing them.

On my current trades, I could easily lose what profits have been made so far. Stops may be triggered early next week, they may run for several weeks longer. I don't know - and no-one else does either. So, in the way that I simply follow orders in terms of entries, I do the same on exits.

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