Amateur speculators (and some professionals too!) often take pride in their willingness to "listen to the market". This usually means that they have some collection of technical indicators which provides information about the direction of the market's trend. The consensus of this collection of indicators then "tells" them whether to be long or short.
People who speculate in this way are usually "trend followers". In other words, they buy only after the market has gone up for a while and they sell only after the market has gone down for a while. There are a (very ) few individuals who have made substantial fortunes as trend followers. But the majority of trend followers has only losses to show for all its analytical effort.
I think trend following is a bad idea. People who do it generally end up as the yo-yo at the end of the market's string. They too often sell near the bottom and buy near the top and are soon out of business.
A better approach is to try to estimate the length of the market's string (to continue the yo-yo metaphor). In other words, try to estimate whether current prices are high or low relative to some idea of a normal price range. If you can do this you can begin to trade futures and stocks like you buy food, clothes, cars, computers etc.
I'm sure you like to take advantage of bargains and sales. You know how big a discount is normal and that discounts are usually available for only a limited time. You like to buy at a discount and defer purchases if things seem overpriced. On the other hand, the logic of trend following would require you to pass up these discounts and wait for the sale to end before buying! Not a good way to extend the purchasing power of your budget!
Identifying a normal discount or premium is the whole purpose of my box theory and of the technique for dividing historical ranges that I illustrate on this blog. These methods help identify support and resistance levels. A market is on sale when it is trading near a support level after an extended drop and is at a premium (or too high) when it is trading near resistance after an extended advance.
When you buy near support after a break or sell near resistance after a rally you are "taking a stand". You are telling everyone that you think the market is under priced or over priced. You are telling other speculators that you think they have made a mistake by driving the market too low or too high. This is a valuable contribution to the price discovery process. You also improve market liquidity by taking the opposite side of the market from overeager sellers or buyers. These are valuable economic services that are not provided by trend followers.
So I say you should learn how to take a stand at support or resistance levels. If you provide a real economic service to the market you can expect the market to compensate you for your efforts.
5 comments:
I think this is a careless posting...while OK advice for experienced Traders (maybe)..it just encourages inexperienced traders to top & bottom-pick with likely disastoraus results.
Just my opinion
Michael
Well, Michael, your view is a common one and I hear it all the time. In fact, 20 years ago I even believed it myself! But top and bottom picking IS possible to do successfully. However, it requires specialized tools and a willingness to look like an idiot on occasion. You can loose just as much money just as quickly as a trend follower as you can as a top and bottom picker! In any case, I think that 99% of "inexperienced" traders shouldn't be trading at all. Take a look at this post:
http://carlfutia.blogspot.com/2005/04/should-you-speculate.html
Carl Futia
i think either way you can profit from it. it depends you personality. my personality tells me i m more like a momentum player, "buy high, sell higher". and that is what makes most senses to me too. but i do believe you can make money on your bottom picking strategy. it is really up to what your comfort level is towards the two totally different methods.
i think any trading idea can be profitable, it just needs a profitable rule. if you know what you are doing, you know the win/loss ratio, you know how to protect yourself from unexpected, even the most risky trade can be a reasonable safe bet.
Whether its trend following or picking bottoms/tops, more than half of your profits or losses are due to the risk mgmt of the position. When you are right and do pick the top (or bottom), you can make a fortune.
Perhaps a refinement to Carl's picking bottoms/tops philosophy is to say that this should be done at higher bottoms or lower tops. For example, picking a lower top in oil now at ~64$ is different than picking the previous late Aug / early Sep 2005 top at ~$70. The same could be said of the Feb/Mar 2003 Nasdaq bottom relative to the October 2002 bottom.
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