Before I get into today’s topic I wanted to let everyone know the that Denver Trading group is hosting a trading forum with 3 days of trading workshops in Denver next weekend. The cost is $249, ($199 if you’re a Denver Trading Group member)’ some meals are included. See here for the presenters and a schedule.
If there’s one trading decision that tends to befuddle most traders and investors alike, it would have to be the decision to trade “with the trend” or “against the trend“. Countless books have been written on the subject, and although there is no definitive answer, here are some tips on the realities of these two different approaches and the proper way to handle each.
The number one mistake many new traders make is to get in on the wrong side of the trend. You can think of this like someone swimming against the tide. The reality here is the trend can save a trader from a not so good selection, and the trend can make an otherwise good selction lose.
First of all, let’s define both approaches for greater clarity. For this purpose, we can consider “trend following” as any strategy looking to take advantage of a directional move in a stock in the time frame being traded. This requires that we make sure that there is an existing trend, and then looking for high odds patterns that take advantage of a continuation of that trend.
Articles on how to do this appear here. Consistent profitable traders know how to cherry pick the best patterns among the best trending stocks.
On the other hand, “counter-trend” strategies revolve around taking advantage of perceived “extended moves” in the directional move of a stock trend. They look to capture the retracements toward some “mid point” or “support/resistance” area. Readers of my articles know that I am biased towards trading with the trend; but what follows is a discussion on the pros and cons of each method and the way you can use each style to obtain the best results.
Trend following styles base their approach on a single simple principle: The trend is the direction of the group in control (bulls or bears/buyers or sellers) and thus; trend following traders will want to take positions using reliable patterns to try and take advantage of the potential continuation of the that direction. These traders have developed “objective” ways to define a trend, its quality, and the odds of its continuation. The idea again is a single simple one: trend followers want to swim with the current. Whenever there’s an established trend, the group in control (buyers in uptrends, and sellers in downtrends) tend to push prices in the direction of the trend. This goes on until the imbalance of supply or demand ceases to exist. An imbalance of supply or demand creates “momentum” that helps them achieve larger moves when they’re right.
How long can any given trend last? That’s always anyone’s guess, and why it’s best not to ‘predict’. Sometimes though supply and demand areas (the same as support and resistance areas) can determine that with relative precision. It is important o know that there will be times when trading in the direction of a trend becomes higher risk, because that trend could be “extended” or nearing a support or resistance area. An example of this is when a new trader buys a stock that has already gone up several days and the likelihood of a pull back has increased.
Counter trend styles base their approach on trying to capitalize from those “pull backs in a trend. If you take any given chart displaying a decent trend, (many are going sideways and should be avoided), you’ll notice that these “pull backs” take place, but when compared with the moves with the trend, they tend to be smaller in size and shorter in time.
Timing of execution is a tighter issue when dealing with counter trend trades, as the act of swimming against the current makes them a greater risk. This is not to say pull backs against the trend are not tradable, but that such a trade has a smaller potential and greater risk for failure.
You can read about learning how to spot the trend in a stock here. Just look for the article on ‘How to Determine the Trend’. The basic principle of trading with the trend can save a new trader from blowing up their account. The idea of taking anyone’s stock tip and buying it on faith (faith is not a trading plan), will seem silly once a trader learns to apply this simple concept, and it only takes about one second to see in any stock or index chart once you know what to look at. It is a hard and fast rule in every professionals trading plan.
Trade with a plan.
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