Saturday, October 27, 2018

Trading the line of least resistance

A lot of the people who were profitable in 2008 became unstuck the following year. They seemed to get in their head that, once the markets started rallying, they were anticipating a further, more pronounced price drop.

In the summer of 2009, they got their chance. There were numerous trading blogs of the day talking about a 'head and shoulders' pattern which had formed on the indices between May and June, and they were going to use this as a trigger to go short the market, and really make a killing.

Here is the chart of the Dow from that time (The S&P500 is almost identical). I'm not an expert on chart patterns, but if you look close enough you can see what they were referring to. I've marked with a red arrow where the supposed entry was going to be.

Well, the big day arrived and... the market didn't really move that far, before subsequently taking off in the opposite direction!

A lot of the "gurus" around from that time went quiet, before disappearing, still adamant that a major downtrend was upon us. Others continued to redraw trendlines or other chart patters, or changed the letters and numbers on their Elliot Wave charts to suit their bearish narrative.

Well, I don't have a crystal ball, and have no idea what is going to happen going forward, but they might finally be proven right - the only problem is they were 9 years out in their timing, and the Dow is currently 16,000 points higher...

It is quite easy for people to get into their mindset of being a 'Perma-bull' or 'Perma-bear'. Quite often, this arises as a direct consequence of how things have turned out following some prior prediction or forecast.

This also happened to some market commentators who became famous due to prior market calls. People like Robert Prechter and Joe Granville spring to mind.

Within the current market conditions, you can see the 'Perma-bull' mindset at work. 

People who have been conditioned to buy the dip over the last few years have been getting a nasty shock with the spike in volatility combined with the recent downward move. What happened in early February this year was a warning shot. Hopefully those who got their fingers burned then learnt their lesson.

What these people have forgotten is that buying the dip will continue to work until it doesn't, in the same way that shorting the rallies will continue to work until it doesn't - or that buying breakouts works until it doesn't.

Price does not solely trend in a single direction. And no-one can know with any certainly when the market will change from one 'state' to another. But I guess a lot of people who have come to the market since 2009 will have only known the indices generally moving in one direction.

Trend followers develop their skills and mindset to avoid falling into either 'Perma' camp. We are quite comfortable following the trend, long or short, and are purely reacting to the direction the markets they are looking to trade are moving. 

In other words, we are happy to trade the line of least resistance. We trade what we see, not what we think we should be seeing.

All we require is a trend - the direction is not a concern. We also are not restricted or bound by any prediction or opinion about what may or may not happen. We simply place our bets in accordance with our rules, and wait to see what happens.

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