The very best trades never go wrong. A wonderful reaffirmation of
the underlying justice of the world (for a trader) is a trade that is
profitable thirty seconds after it’s put on and never looks back.
Most likely, it’s a trend trade, one associated with a steady advance
or decline in pricing, though it could be something that meanders
in a slightly profitable zone.
A one-note trading strategy will usually find this situation and
ride it. That’s fine. That’s progress, but there’s more to be done.
We’d like to extract every bit of profit that’s coming to us and the
way toward that in a trend is to pile on. The questions are
“Where?” and “When?”
Briefly, “where” means continuously during the advance and
“when” is when prices are cheap or dear during an advance or decline.
I believe these verbal rules can be executed objectively by
referring to your experience with the market and Chapter 5 is devoted
to this topic, but for now take it that a period of trending is a
time for working, not just waiting.
Not that waiting is bad. It was LeF&vre15 who said he made
most of his money waiting. Once you have your positions, you do
wait. However, in the campaign mode, you must constantly seek
new positions using a variety of entry criteria. Like an infantry
company commander, you’re always patrolling your front, probing.
During a trend, it’s the same.
Breaking Out
Actually getting to a trend from a trading range is a little tough.
First of all, under my scheme, you’ve been trading back into the
range, so to get right with the new trend you have to take a loss and
reverse.
Perhaps more difficult (because the trade could be executed mechanically
by an executing broker) is reversing your mindset. I
won’t dwell on psychology in this book (though I’m not above referring
to the phenomena all traders know),16 but you should know
that it’s because I found it nearly impossible to decisively reverse
my own opinion that I had to develop a trading system that could
be mechanically implemented. I’m in awe of traders who can, on
their internal fortitude, see they’re wrong and get right. I found out
early that I wasn’t one of them, and just about everything you see
in this book is the result of an effort to get my snap judgment out
of the way of making money. I hope to show you a way where your
judgment in analyzing experience can lead to mechanical rules for
analysis and execution.
Perhaps reversing with a loss won’t seem so bad to you if you’ve
had the good fortune to be trading a range and just traded
profitably across the range to your breakout point. If, say, your
range is 90 points, you’ve built up a profit over what turned out to
actually be the start of a trend at the bottom of the range. If, on
the other hand, you’ve just gone from a downtrend to an uptrend,
you will cash in your profit from the previous trend and immediately
reinvest in the new move.
Adding Positions on the Trend
Once we’re into a trend (and the best early indicator is the entry
trade that never went bad), it’s time to add positions in the right direction.
The best place is when prices are cheap or dear relative to
the advance or decline measure (in this book, a short, moving average).
Others use trend lines or trading bands. Waves of advance may
be as small as stairsteps or as pronounced as retracements, but if
we’re genuinely into a sustained advance the underlying channel can
be marked out using averages, trading bands, regressions, or trend
lines. I prefer averages, simply because they can’t go wrong and, in
my experience, they have been consistent over the past 12 years.
Use an average that skims tops and bottoms of declines or advances.
You’ll probably find the length of the average is remarkably
similar to the cyclical content of the data series.” All you really
need to know, however, is that one characteristic or element of experience
that tends to define the trading channel for you during advances
or declines. You’re free to set it as tightly as you like. Just
keep in mind that when prices decline to an advancing average during
a trend, your buy order will be waiting for them.
On the other side of the channel, prices will be genuinely frothy.
If people are paying up or selling out at an extreme, prices must be
dear or cheap. If dear, let’s sell some things we bought cheaply; if
cheap, let’s buy some things we sold higher. Caution: Don’t drop
your underlying position. Whether you’ve kept it constant since
trend entry or have added to it, just squeeze out the add-on trades
you took as the price fluctuated about its line of trend.
Ending the Trend
Just as I was not worried about the “optimal” trading rule, I’m not
worried about your exit. As long as the exit rule is specified going in,
we can observe the actual gains and losses from the trading strategy,
which means we can control losses and thus end up winning.
It’s unrealistic to shoot for the top price in an uptrend. That’s
not going to happen except by a statistical fluke (the price extreme
probably has a volume of one). At the top, as all along the way,
traders are oscillating about some changing concept of value,
searching for levels that will generate transactions. Who knows
what has changed in the fundamental world, if anything? You’re
probably not privy to it or aware of it. Folks who are privy wonder
if what’s changed will make a difference. The uncertainty is resolved
by sheer weight of numbers and the timing of actions taken
by disparate traders. When that weight shows itself in price reversal,
it’s time to act.
The issue for the campaigner is whether the reversal is simply a
reaction in a trend, a reversion to trading range, or a complete reversal
of trend. Only the price’s action can ultimately tell, and in
the process of fighting over this terrain, more tactical loses will be
taken, eating up some of the gains from the trend. The basic clue
will be violation of the theory we had before: that advancing trending
prices should be roughly contained along the lines of our advance,
whether those lines are trend lines, averages, or whatever
method you use. It is the violation of the previous theory that tells
us change has occurred, not (or, rarely) fundamental news.
Read More : What You Should Care About Trend Trading?
