Wednesday, 2 July 2008

The Trend is Your Friend? With Friends Like That...

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"The trend is your friend."

The version I like better is legendary trader Ed Seykota's: "The trend is your friend, till the end, when it bends."

"The real money is to be made from the trend."

There is much that has been said about the art and science of technical analysis (translation: the art of reading a chart of historical prices in the hope of predicting where the market is going to go next). Trends, in particular, are a key subject although they can be tricky to define.

The problem with this is that it makes the assumption that the market is always trending. It isn't. In fact, there's a good proportion of the time when it isn't. I believe Curtis Faith in his book Way of the Turtle talks about four states the market can be in:

1. Stable and Trending
2. Stable and Non-Trending
3. Volatile and Trending
4. Volatile and Non-Trending

If you consider this chart. It's trending, right? Well, yes, from this perspective. If you consider just the period from March-April, though, it basically went nowhere. It wasn't trending. Feb was clearly a trending month considered alone. But if you looked at the chart for just Feb-Mar, it would be another potentially non-trending case.

Basic point: Trends are irrelevant unless you know your trading timeline.

Although in theory you can choose your timelines, I suspect that it is pretty much fixed with each individual. It's largely affected by

1. Degree of risk tolerance
2. Patience
3. Pain thresholds
4. Money management

It's a pity that traders tend not to listen to self-development experts and vice versa. The self-developers could teach them a lot of neat tricks to handle fear and greed, and a few of the problems in the human development edge could be solved by insights from the market, which actually mimics real life rather well.

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