The trend is your friend. This is a fundamental saying of technical analysis.
Learning technical analysis can be a fun and rewarding experience. As we progress along our technical analysis education journey, we will be learning about many techniques, indicators and formations. But before we get too involved, it is important to discuss one of the most basic tenets of technical analysis: investing WITH the trend.
One of the fundamental concepts of technical analysis is that markets, including stocks, futures, forex, etc., tend to rise or fall for extended periods of time. While they do not go in a straight line, but in jagged moves, there is an overall direction or trend to prices. Typically, one of our first tasks is to identify this trend.
There are, of course, also times when the market is not trending. It may be choppy, going nowhere, or it may be moving sideways. We also need to know when the market is not in a trend.
We have a lot of tools at our disposal to help us to identify these trends. These include trend lines, moving averages, Bollinger bands and more. We will be covering each of these in separate articles.
Don’t Look For Turning Points
In general, we do not seek to identify tops, bottoms or turning points. We instead look to first identify what is the appropriate trend for the time frame being studied and ride that trend. Thus, at tops. bottoms and turning points, we wait until a trend has been established and then trade with the trend.
The Middle Sixty Percent
Thus, in a reversal, we do not get into the trade until around twenty percent of the trend has already been traced out. When we exit our trade, we often do the same thing, that is, verify that the original trend has been reversed. Again we often lose around twenty percent of the trend.
There are, however, times when we receive a reliable signal that the trend has ended, although a new one has not yet been confirmed. In that case, we may not lose all of the second twenty percent,
Thus we have no regrets that we missed almost half of the trend. Rather, we are quite happy with our 50-60% of the trend, because we were pretty certain that a trend had started when we invested and pretty certain that it had reversed when we got out. We did not have a lot to worry about.
Should We Ever Buck The Trend?
Now this is not to say that there are no trading strategies that go against the trend (generally they are instead picking out a shorter trend), but we need to be absolutely sure that is what we want to do. If you find yourself looking for tops, bottoms and turning points, you really should ask yourself if this is really what you want to be doing.
Your goal as a fledgling technical analyst is to, first and foremost, identify the trend. Don’t jump the gun to try and gain an extra five percent or so. Make sure that a new trend has formed. There may be reasons, however, to get out of a trend early, such as a profit goal or worrisome market conditions, but don’t take small gains just to feel good about your trading.
We all want to have good friends, and, for a technical analyst, the trend is your best friend.
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