Stock Trading 101 – The Trending Market

The trending market is a market with strong direction. Trading is about increasing your chances of success and reducing your risk and research shows that by simply sticking with the trend as your trading strategy of choice your win-loss ratio is on average 55%-45%. Small advantages like this translate into huge gains in the long-term. Hence the expression “the trend is your friend”.

Every trader has a different time horizon. When making trading decisions it is important to make sure that your trade horizon coincides with the trend horizon you research. There is no point to execute a day trade based on a 5 year trend analysis. The confirmation that short-term trades fit into long-term trends is a positive sign to a trader who wants to trade on the shorter timeframe. For example, oftentimes it is useful to verify that the price action on a daily chart is validated by the long-term price movement on weekly chart.

The chart below displays a multi-year downward trend for RIMM as iPhone and Android devices starting eating market share from the Blackberry.

This next chart displays the strong upside move for MSFT that followed the announcement from the Federal Reserve that they will print 1 trillion dollars at the height of the financial crisis in March 2009.

A certain type of strategies called contrarian try to make profits from corrections in the trend. There are several problems with this approach

• The probabilities are already against the trader because of the 55%-45% ratio that favours trend trading.
• The sizes of the moves are limited because corrections simply allow the market to consolidate at new levels before it tries to reach higher or lower prices(depending on the trend direction).
• The commission costs are higher because the trader may be forced in and out from even profitable trades more often because the trend will always try to resume.
• The stress is higher which always increases the chance of poor decision making.
• Contrarian trades require more time to manage so the trader cannot use this time for research or other activities that may generate higher long-term value.