The Trend Commandments

 

The principles that successful trend traders use to make money in the markets is difficult for the average investor or trader to understand.

Readers unfamiliar with systematic trend trading have a hard time grasping the concept of trading for profitability without trying to predict where price will go next. Most successful trend traders have preset planned entries that are triggered by a reaction to a new high or low price being hit. They use quantifiable price levels and indicators like moving averages to know when to enter and exit a trade and do not rely on any attempt to ‘know’ what will happen next. They buy or sell short in the direction of the dominant trend when they get a signal that shows the potential for a trend, they do not predict the trend… they simply attempt to follow it.

Even though many professional trend followers that manage money have had huge long term gains and have compounded managed capital over many years, some critics complain that many trend traders have large draw downs. While 20% drawdowns are unpleasant to trade through, traders of all types do have drawdowns and many traders that trade against trends and do not manage risk carefully blow up eventually. It is very difficult to argue with the many trend followers that have made fortunes with reactive technical systems over the long term.

Anyone who says they can predict the stock market with certainty cannot be trusted. It is delusional thinking to believe they are smarter than all the participants and can see all events that move markets ahead of time without the aid of a working crystal ball or time machine. Trend followers simply use preset price signals to identify trends, they manage their risk on every trade, and they follow their system with great discipline.

As long as markets trend then trend-followers will be winners in the zero sum game over long term.

Here are some of the commandments they trade by:
1.    You shall back test and develop quantify robust trend trading systems that are profitable over the long term.
2.    You shall identify and follow the long term trend in the markets you trade, and have no guru that you bow down to.
3.    You shall not try to predict the future, that is a fool’s game, but follow the current price trend.
4.    You shall remember the stop loss to keep your capital safe from destruction; you shall know your exit level before your entry is taken.
5.    Follow your trend following system all the days that you are trading, so that through discipline you will be profitable.
6.    You shall not give up on your trading system because of a draw down.
7.    You shall not change a winning system because it has had a few losing trades.
8.    You shall trade with the principles that have proven to work for successful traders. Manage risk, go with the trend, and diversify so your days in the market will be long.
9.    You shall keep the faith in your trend following system even in range bound markets; a trend will begin anew eventually.
10.    You shall not covet fundamentalist’s valuations, CNBC talking heads, newsletter predictions, Holy Grails, or the false claims of any of the black box systems.

Best Elliott Wave Traders on Twitter

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                                                                                                                                                                                                                                                                                                                                                                                                                       Chart courtesy of stockcharts.com

The Elliott Wave Principle is a from of technical analysis that some traders use to analyze financial market cycles and forecast market trends by identifying extremes in investor psychology, highs and lows in prices, and other collective factors. Ralph Nelson Elliott (1871–1948), a professional accountant, discovered the underlying social principles and developed the analytical tools in the 1930s. He proposed that market prices unfold in specific patterns, which practitioners today call Elliott waves, or simply waves. Elliott published his theory of market behavior in the book The Wave Principle in 1938, summarized it in a series of articles in Financial World magazine in 1939, and covered it most comprehensively in his final major work, Nature’s Laws: The Secret of the Universe in 1946. Elliott stated that “because man is subject to rhythmical procedure, calculations having to do with his activities can be projected far into the future with a justification and certainty heretofore unattainable.” The empirical validity of the Elliott Wave Principle remains the subject of debate. via Wikipedia

When most people hear about the school of Elliott Wave Trading, many are immediately dismissive of the theory.  In large part, this is due to the stubbornness of Robert Prechter during one of his famous market calls. Prechter’s mistake was that he believed he had an infallible crystal ball, rather than going with the flow and reacting to price action. Most technical analysts, stock traders, and trend followers zone-out when talk of waves and ABC patterns arise, much like the general public does when traders discuss chart patterns, risk management, and trader psychology.

I have been more open to the convergence of Elliott wave patterns with traditional moving averages and chart patterns. Why? I have seen some Elliott wave traders utilize this method with great success. I have watched them trade in real time, over long periods, achieving fantastic results. If some of the best traders I know come from Elliott Wave City, then I have no choice but to go for a visit.

 

Here are four of the best Elliott Wave traders I have seen on twitter:

 

Understanding Market Movement

 

 A few key points to remember when analyzing market movements:

  • Uncertainty causes much of the volatility, as neither buyers, sellers, or holders have the majority conviction to control the trend.
  • Unexpected good news causes the market to (generally) go up as the new situation is priced in.
  • Expected good news is usually sold into when announced, because the majority already bought expecting the trend up. All that is left is profit taking after the catalyst has passed.
  • Expected bad news can cause rallies because the people who want out are already out. When the event passes, the sellers are exhausted and buyers are now safe to take positions.
  • Unexpected bad news can cause big sell-offs as new information is priced in, and fear grips holders who panic and sell.
  • Bear market bottoms happen when all sellers are exhausted in an environment of maximum pessimism. The worse case scenario is already priced in, leaving nowhere for price to go but up.
  • Bull markets top when there is maximum euphoria and the majority believe there is easy money to be made. They believe that a paradigm shift has happened and the markets have changed permanently.
  •  In the majority of cases, strong up trends in the 10 day simple moving average acts as support. In very strong up trends, the 5 day exponential average acts as support.
  • Strong bull markets bounce after touching the 50 day simple moving average. Very strong bull markets bounce on retracements to the 21 day ema.
  • The 200 day simple moving average is the ultimate line in the sand between bull markets and bear markets.

Magic of Compounding Returns

 

Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” – Unknown

When I was a teenager, I was fascinated with compounded return tables. They seemed like magic to me.  I knew that at some point in the future, I could build up my capital to the point where it made more than I did. If I managed my capital correctly, and could return 12% a year, it would double at the end of the sixth year. If I could really knock it out of park and return 20% a year, I was looking at doubling at the end of four years. The key would be to figure out how to do get these returns through the stock market, and how to get the capital in the first place. I decided I would sell my time for work, and then put that money to work in order to save time in the future.

I have been fortunate to make my teenage dreams come true, and over the past 20 years, I have created this compounding in my accounts. For me, capital preservation is the key. Grinding out 15%-20% returns a year can work magic in a few years, and if you throw in a few 40% and 50% return years in great trending markets, you can build capital quickly. When you have six figures in your personal trading accounts and 1% of capital is over $1,000, it gives you tremendous trading firepower.

If you have never pondered the power of compounding a trading/investing account for capital appreciation, please give this chart your attention. It is possible to be a millionaire in a reasonable amount of time if you leave your capital alone and let it grow. This is a program that anyone can use with simple trend following methods. Using an index and moving averages is not rocket science. Implementing this inside a tax deferred account like a 401K, 403B, or IRA eliminates the capital gain taxes. The key is to start building early at a very young age. Once you get into the six figures, the acceleration of the growth is amazing.

[Tweet “Using an index and moving averages is not rocket science.”]


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How to Trade the Election Results

 

 

 

 

 

The biggest question I have received today from everyone, new traders, friends, family, even my wife is “What will happen to the stock market if Obama wins?’ or “If Romney wins will the market rally?”

How should we trade the election results? …..Don’t.

Do not let the results color your trading, trade price action, trade the chart, trade your system. Continue to manage risk and stay disciplined. Take your entries and exits just like you have always done inside a winning methodology.

If Obama wins and the market gaps under support tomorrow and begins a downtrend for multiple days then it may be time to go short. If Romney wins and we gap up tomorrow and the market starts to trend upwards then it may be time to go long. If the election is too close to call then…trade the chart, trade what is actually happening not your own opinion of what should happen. The answers to how to trade the price action should be based on your methodology and the time frame you trade on not who wins the election.

Everybody wants a prediction but no one has a crystal ball, the best traders I know trade the price action not their own predictions.