Sunday, March 27, 2016

Thoughts on what price action to focus on, timeframes and parameters

I've talked in the past here about how the indices are constructed, and given an argument as to why you may want to avoid following them 'parrot fashion'. It generated some interesting comments from readers, so it is worth a read.

Remember that, if you trade individual stocks, you are trading just that, and not the stock market as a whole. This point may well be anathema to a lot of people who trade using a 'top down theory' of analysis, and that's fine. I am simply putting forward a different point of view or belief.

Getting a short signal on an index doesn't mean you should start shorting everything in sight, nor does it mean you should exit existing positions, particularly if they are in developing uptrends.

Similarly getting a long signal on an index shouldn't be the trigger to start buying everything, and you certainly shouldn't bail out of existing short positions that are currently in a downtrend. What happens if those signals on the indices quickly fail themselves?

This point was reinforced to me in conversation with a trader I follow on social media, who also trades trends in individual stocks: "If I am trading Google, I follow price on Google, not the index".

How you determine an uptrend or downtrend can also influence your own trading directional bias. This could depend on the timeframe or parameters you are using. As we know, there is no one trend in an individual market. On weekly timeframe, the trend could be down, yet on the daily chart, it may be up, the hourly may be down, and so on.

Whatever your preferred parameters are, there will always be stocks breaking out to the upside in market downtrends, as well as stocks breaking out to the downside in market uptrends. You could argue that if a stock is breaking out in the opposite direction to the trend in the indices, then there may be something unusual going on in that stock, creating a high level of relative strength or weakness compared to the general market.

In addition, you can get situations where decent trends develop in stocks in the opposite direction to each other, at the same time. An example of this was discussed here.

Perhaps reflecting the short-term strength in the indices following the lows made in February, recently I have been seeing a lot more long setups than short setups come up on my own scans. That reflects the fact that my own parameters are at the shorter-term end of the trend following scale.

Those who trade long-term trends may not have seen the short signals given around the turn of the year (and the subsequent downtrends) invalidated, despite the markets ticking up over the last month or so, and are treating this price move as a counter-trend rally within the context of a longer-term downtrend.

Neither approach is wrong, providing:

  • whatever method you are using has a positive expectancy;
  • you are sticking to whatever rules you use to determine your entries and exits;
  • you don't start mixing timeframes or parameters when you get into a trade.
I know I don't have the patience to trade those longer-term trends, and I certainly wouldn't be able to sit through several weeks of price going against me but not triggering an exit signal. Hence that is why the parameters used to define trends, exits and exits suit me, and they may not suit you.

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