Why Trading Against the Trend is like Picking Up Pennies in Front of a Steam-Roller
Once you’ve traded for some time you’ll have a library of trading anecdotes, some are personal, some are second hand or third party. Whilst supporting my youngest Son playing football at a tournament this summer I got into conversation with another Dad. It’s not ignorance on my part but I rarely ask other parents (or people I meet) what they do, if they want to divulge it or directly ask me the question then fine, but it’s not a question I ask or information I volunteer. To be honest a lot of folk ask the question to establish where you fit in with their culture, their perceptions and pre-conceptions. If asked I simply state that I’m a foreign exchange currency trader and market analyst, that generally does the trick; blank stare, potential conversation killed and to be honest I’m cool with that.
However, this parent probed a little more with the standard; “oh, I’m going to Spain in a few weeks, any idea what the euro’s gonna do?” I stifled the mental yawn, (lost count of the times I’ve had this question posed to me) and my reply, whilst smiling through gritted teeth, was short and to the point; “no idea to be honest”. He looked puzzled so I thought I’d add a bit more meat on the bone; “look, here’s the thing, sterling versus euro is currently in a down trend, the trend has lasted approx. a week, could be entering a period of consolidation were it eventually turns in sterling’s favour but honestly your guess is as good as mine, I follow trends, I don’t make (or trade) predictions, not mine or anyone else’s”..That’s where the exchange stopped, he still appeared puzzled, perhaps he thought I’d be a market wizard, ready to impart some secret prediction on where the euro was headed, but no, I’ll always be the sorcerer’s apprentice, and that sorcerer, the market, always has plenty of tricks and spells up its sleeve…
Recognising a trend, trading with a trend, trading against the trend, staying out of a range, trading both ranging and trending markets..these decisions come down to one crucial issue; do you want to fight the market or work with it? Whilst there are many successful ‘mean reversionists’ out there in our FX trading community the overall ‘job’ we do can be exacting enough. Why anyone would choose to compound that degree of difficulty, as opposed to choosing the path of least resistance, will always remain a mystery as it’s an anathema to many traders, particularly swing and position traders. However, surely day traders and or scalpers could greatly enhance their results if they trade only with the trend as opposed to against it and the market? Just take the trades in line with the trend and pass on those against, always look for higher time frames to determine direction.
How to identify a trend should be a straight forward exercise, if you prefer to trade forex off, for example, a 1hr time frame then using exactly the same method you trade off 1hr you use to determine whether (or not) the trend is established or beginning to become established on: the 2 hr, the 4 hr and perhaps the daily time frame. If so (and if you trade with that trend) then the probability of your individual trade being successful and more importantly profitable is greatly enhanced.
Many experienced and successful traders, (the two adjectives always go hand in hand) refer to four rules that should be part of every traders trading strategy and written into the bullet proof evolving trading plan each trader should work from.
- Trade with the trend
- Cut losses short
- Let profits run
- Manage risk
Trading with the trend relates to the decision of how to initiate trades. You should always trade in the direction of recent price movement. You should hardwire that rule into your ‘trading being’ as even if you are a day trader, perhaps trading off 15 minute time frames looking for circa 20 pip gains, statistically you are far more likely to have winners with the trend as opposed to trading against it. Mathematical analysis of market price data in the past proved that price changes are primarily random with a small trend component. This scientific fact is extremely important to those who intend to pursue trading and forex trading in a rational, scientific manner. Any attempt to trade short-term patterns and methods, not based on trend, are arguably statistically far more likely to fail. Successful traders use a method that gives them a statistical edge. This edge must come from the tendency of price to trend. In the long term you can only make money by trading in synch with these market trends; when prices are trending up, you should only buy, when prices are trending down, you should only sell.
This important principle to trading success is well-known, so why do so many traders constantly violate it? As ‘consumers’ we appear to be wired to search for bargains, we therefore obsess and try to buy at the very bottom, or sell at the very top before new trends become established. Winning traders have learned to wait until a trend is confirmed before taking a position consistent with that trend. The key principle is to to ignore attempting to predict markets and simply trade the trend. When you trade in the direction of a trend you are following the markets and market price rather than predicting price and the vast majority of unsuccessful traders spend their trading careers looking for better ways to “predict the market”. If you develop the discipline to measure and identify trends, using intermediate to long-term time frames, whilst always trading in the direction of the trend, you’ll be on the right path to profitable trading.
The alternative to trend following is predicting. This is a trap that nearly all traders fall into particularly when they first discover trading as a potential profession. They look at the markets and conclude that the best way to be successful is to learn how to predict where markets will go in the future. Anticipating trends is an impossible task, and trends are where the bulk of profits are to be harvested. You can only define the concept of trend in relation to a particular time frame, your preferred time frame, a key part of any trading plan is deciding which time frame to use for making decisions. It’s easier from a psychologically viewpoint to keep the time frame short as trading with the trend can be difficult to develop as a skill, the larger losses if you’re wrong can be very off putting for fledgling traders. But undoubtedly the best results come from longer-term trading.
The received wisdom is that markets trend twenty percent of the time and range in consolidation eighty percent of the time. The skill is defining where the trend starts and where it stops. When your market trends you get in at the right time, ride that trend, then exit at the correct point. Therefore your profits should offset the losses you take during ranging periods. As traders we have to accept that we don’t know when the market’s going to trend and when it’s going to range. In fact, it’s foolish to predict anything it does. Don’t trade predictions, react to the market. To increase your chances of success, the time frame to measure trends should be at least daily. You should only enter trades in the direction of the price trend clearly visualised and displayed on a daily chart, how long that trend should be established on your daily chart before you enter obviously varies and that’s down to the individual trader. Working ‘backwards’ can you clearly see the trend on your one-two hour time frame and the four hour time frame? Then the chances are that you’re trading with the trend.
It really is that simple to make a key decision with regards to your overall trading plan, experienced traders on occasion give themselves a mental slap to remind themselves of the basic fact that the probability of any given trade’s success is greatly enhanced by trading with the trend. If this article has found you as a fledgling trader struggling with the concept then you may have learned in the ten minutes taken to read this article information and a lesson many traders have taken months, years and significant losses to learn.
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