Is The Trend Really Your Friend?

One of the most prevalent axioms found in conventional trading books is that you must trade in the direction of the prevailing trend in order to be successful. How many would-be traders haven’t heard the refrain “the trend is your friend”. These same books also tell you that the biggest “no-no” is trying to pick tops and bottoms. On the surface it seems like pretty reasonable advice. However, because most markets are a zero-sum game, you have to be careful looking at the markets through the spectrum of conventional thinking.  Moreover, if trading was as easy as following the trend why is it that statistics show that 90% of traders lose their money in a 12 to 18 month period of participating actively in the markets? If you understand the proper skills on how institutions are highly profitable buying low and selling high, picking tops and bottoms should be highly feasible. In this article we will explore alternative, low-risk entries, that will allow us to anticipate trade changes and thus not fall prey to the high risk way of looking at trend analysis.

Conventional technical analysis teaches that one must always wait for trend confirmation. One method is done by connecting a series of highs, or lows at three points. A second analysis is where moving averages sloping higher confirming an uptrend.  Price confirmation of trend can also be used by simply identifying a series of higher-highs or lower-lows. This is all text book stuff that most of you already know.  So, why am I going over? The answer is, although we may be able to use these tactics, the fact is, if we utilize them in the wrong manner we will end up taking high risk trades; which will result in us losing more of our hard earned money more often than not.

The reality is market trends are formed by saw-tooth type patterns, not straight forty-five degree angle lines. These undulations tend to trap trend traders because they wait for too much confirmation before they engage the trend. The most likely reason this happens is because of how traders are conditioned to trade trendy markets.

An example of this flawed thinking is, when a market is trending higher it’s safer to buy when it makes a higher peak. Conversely, lots of traders are trained by many conventional trading books to sell only when the market breaks to a new low. When the market is trending higher, most of the new peaks are followed by counter-trend moves otherwise known as corrections. Therein lies the problem when buying after the new high price has printed because until after price holds a higher low point can you conclude that the down move was indeed a correction. If it breaks, conventional analysis tells you that a trend reversal may be in the making. This is lagging information, and thus will never produce a low-risk trading strategy.

Likewise, in a downtrend, when the market breaks to new lows, an upward move ensues. Traders waiting for a break in price before shorting will encounter the same difficulty.

As stated before, in order to engage the market trend in a lower risk manner, we have to utilize a different tact than the conventional thinking espoused by the trading books. A lower risk approach would be to anticipate where the uptrend would reverse and vice-versa for the downtrend. This happens most of the time at higher time frame quality distribution and accumulation zones.  When I refer to quality levels, I mean levels that score high using our odds enhancers.

A recent example of this was in the Wheat futures market. In the chart below we can see wheat was in a strong 60 minute uptrend (as defined by the conventional trading books), then reversed strongly as it touched the selling (distribution) area at 561 2/8.

The bottom line is that “anticipatory” trend analysis done in a low risk strategy format can be very rewarding.  This is by far the most important aspect. This is, because, by the time everyone’s figured out that the market is in a strong trend is usually when the market is likely to reverse and trap most trend followers.

Until next time, I hope everyone has a fabulous trading week.

Gabe