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The first two rules of trading are:
1) Don't fight the trend.
2) The trend is your friend.
What is a trend?
There are three trends in a market: 1) The Primary Trend, 2) The Intermediate Trend, and 3) The Immediate Trend. As traders, the one that matters is the Immediate Trend. That is the
trend we will discuss here.
The novice trader approaches buying securities the way they approach buying everything else: buying on sale at a lower price is better than paying more for it than it was selling for yesterday.
However, in trading it is better to buy a security that is up 10% than down 10%. A security that is up 10% is more likely to
go up another 10%. A security that is down 10% is more likely to go
down another 10% than to go up.
The terms overbought and oversold are not to be given too much weight. These terms tend to keep traders away from the best trades. Overbought securities tend to get more overbought and oversold
securities tend to get more oversold. The natural instinct we have to avoid paying more today for something that was cheaper yesterday needs to be re-trained to see these as
newly identified opportunities rather than missed opportunities.
When the trend is up, then that is trend you have. Do not trade the trend you want, need, or expect to happen soon. Don't trade a change in the trend until there is
good evidence that a change in the
trend has actually arrived. If you were driving down the road and you expected to turn left soon, you would wait until you could see the turn at the corner -you wouldn't just turn now when the
corner was not yet in sight.
Often you will be in a trade and you
will feel that the trade is "long in the tooth". Unless some reasonably objective criteria is met, you need to stay in that trade.
You must let your winners run as long as they can to be a profitable trader. Often trades will last much longer than you think because their trend is very strong. Cutting winners
short is a sure sign of a novice trader.
Bill Fleckenstein started shorting the market in the mid 1990's based on excellent research. However, it was not until March 2000 that the research began to pay off. He kept his fund alive with
some winners here and there, but if he had waited until the market actually turned then he would have made far more money. He was fighting the trend by shorting too soon. He should have held his
nose and gone long for a few years first.
Valuation and macro-economic factors influence the price action but they do not determine it. There is normally an offset of several months between market tops/bottoms and economic tops/bottoms,
if there is any relationship at all.
When a person becomes a trader, they typically learn to trade in a specific environment (bullish or bearish). This often casts a bias on their trading style forever. The best traders are largely
free of a market bias.
It is best to leave your opinions behind when you enter your trading room. The market is no respecter of opinion or logic. It never does what it should do, except to do so
just long enough to sucker the
opinionated people in to the wrong side of a trade.
In August 2010 the market reversed its Intermediate Trend and Intermediate Trend in a move that would gain more than 20%. The move didn't make sense because the macro-economic news was very bad and there
were no signs of improvement. As the market moved higher, the big hedge funds INCREASED their short positions because they believed their macro-economic research more than they believed in the trend. As a
result they posted dismal results until they were forced by mounting losses to follow the trend, not fight it.
It is very hard to make money consistently when you are fighting the trend.
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