In an effort to keep this site moving along I wanted to dig a little more into the trend following category today. There are few explanations I have ever read that leave me truly satisfied in terms of how to trade a trend properly. Over the years I have adapted my own methods to latching onto preexisting movements.
First and foremost, many of the materials written out there in reference to trend following tend to ignore the type of trading environment that is underway. And while most people might say something like, “well, the environment is a trend, dummy“, this kind of explanation is broad, vague and can mean any number of different things.
Trends move in stages, and depending on the driver and time at which you are observing the trend, have varying intensities that need to be handled differently.
In short form, I wanted to outline a handful of points that have bailed me out over the years and put into practice to this day.
Rule #1: Expect the continuation.
Yes, while I realize this is a very general statement, the truth is that most people do not. I could supply you with here with statistics that point to the retail bloodbath that ensues anytime an aggressive trend is underway, but I'll spare you.
Expectation of the obvious is something people tend to lack in this business, I suppose in part to the fact that he or she thinks that someone or something is always out to fool them, or some other counter-intuitive thought process. If you expect it, you can not only be prepared for the good, but the bad as well. Most trends will give up something on a pullback as opposed to none, regardless of the stage at which it is being traded. The exception to this statement are V tops and bottoms, which have their own characteristics.
Rule #2: Trends move in stages.
Expecting the continuation of a trend works only as well as the point at which you are trading it. “Drive, Channel, Drive” or “Channel, Drive, Channel” are just two of the ways I'll use to describe the evolution of just about any trend. And even within these larger, more macro patterns you'll find substages on lower timeframes or tick intervals.
For instance, many trends complete with a small channel, which is essentially a triple tap following a sharp drive. This drive is what many people would consider “aggressive” behavior. And by the time this behavior comes to light, many daytraders are just starting to switch gears and think that prices are going to continue, when in fact they are witnessing nothing less than the grand finale.
Rule #3: It is easier for a trend to continue vs. reverse.
Forget about your major support and resistance levels, order flow, etc. etc. in front of the freight train. They will all go bust if the stimulus is strong enough. And trying to “scalp” against these is like picking up pennies off of the train track. It is, for the most part, a useless exercise that almost always ends in ruin. Latching onto the preexisting movement is much easier and about 10X less painless.
Rule #4: The inception of leg #2 tends to drive the most confusion.
Trends can be cut up into “legs”, which essentially distinguishes drives, or sharp movements from one another. Leg #2 gets hairy for a lot of people because this is the leg that can either 1) fail and the previous trend continues or 2) continues, establishing a new trend.
In trends, leg #2 will fail and the preexisting movement will continue. Prices take an intraday pause, reverse, only to fail at more attractive prices for trend followers.These legs themselves can be cut up into two distinct movements and trading accordingly.
Rule #5: Without anything to dictate otherwise, trends keep moving.
While not as aggressive as the inception, trends will indeed continue should no other counter-stimulus take over. This “rule” can be witnessed many times, over centuries, not just decades, and in most markets. For example, I subscribe to a newsletter written by a guy that most people would consider a “permabear”. Since 2010, I have been reading weekly about a range of indicators that always point to the death of the world equity markets. The problem with most of these “indicators” (which are a mix of fundamental correlations, volumes and technicals), is that people give a rat's rear end about them and are focused on a much bigger picture.
People have been there, done that. If it happened the last time (whatever it might be), it will likely not happen again. We learn from our “mistakes” and trade things in a different way, based on our past experiences.
This does not deter from simple supply and demand, however. If the demand is there, people will buy. If a lack thereof, people will sell. This much never changes.
Others? Please post them below. Needless to say this is a topic that is hard to exhaust.