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Managing and Understanding the Nature of Trends

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A trend represents the evolution of public sentiment, specifically, the psychology between optimistic market participants (bulls) and its pessimistic counterparts (bears). Moreover, the angle of a trend can determine whether the market’s mood is extremely optimistic or extremely pessimistic.


One thing that is very common of traders is that they consistently take a pounding from the market because they do not understand the underlying forces of trends. If the market is visibly moving down, sellers possess greater authority while buyers are countering against the seller’s strong influence. In the bigger perspective, such upswings are mere counter-moves on the way down. Buying is thus a much more challenging proposition than going with the dominant force. The opposite applies to rising markets in which buyers are in control.


If a market is in a decline and a trader is short, there is no point in covering, buying, and shorting again lower and lower because he will not be accomplishing anything of greater significance. What is the advantage in being exposed to new risk if a market is in an obvious decline already? You should stay short in a downtrend and not be overly concerned about reversals against you. On the contrary, there is no point in buying into every dip in hope for a massive recovery rally. New spikes on the way down are a necessity and a chance for bears to adjust their stops lower, thus reducing their risks or even secure increasingly more profits.


If you think about why markets move up and down: It is because there is an ongoing war between bulls and bears. These two opposing groups behave like armies on a battlefield. The aim of the bulls is to push markets up because they make money if they are successful, but they forfeit money if they are not. Then you have an opposing crowd that is just as intense as bulls in moving markets to the opposite direction. We basically have two enemies with two very different goals.


The bottom line is that all up and down movements are actually the result of a dynamic battle being fought out between these two forces. Significant battle lines are drawn days to weeks before, and have an immense impact on how the market moves the following day. A fight for control is taking place at these lines and are what we call a support or resistance area. As the bulls advance, the bears retreat and regroup at the next resistance. There, more bears enter the market in hope to overwhelm the bulls in a larger number to push the bulls back down toward support. Bulls regroup at support with the goal to push the bears back up towards resistance again. It is a cycle that appears in all markets.


What is being exploited for profit is the dominant trend of the market. We do not make money by predicting support and resistance areas, but by catching turnarounds there. Once a trend is initiated after such a turnaround, it is not going to stop right away, but it will continue for an extended period. The ignition will trigger a chain reaction of orders that will predominantly serve the winning army’s interest. In an uptrend, bullish traders are making more and more money while bearish investors need to cover their shorts and reverse their position which, in turn, gives further boost to the ongoing uptrend.


Obviously, those market participants holding long positions will not easily give up their money-printing machine and stick to this position for as long as possible. Same for the former bearish participants who are finally starting to profit, expect the trend to continue. A trader’s fear that the market would turn against him any moment is usually unjustified. The challenging part is to stick with a position through thick and thin until the position is stopped out for good. Prior to this, a trend follower’s job is easier than you might imagine: wait and sit on your hands.

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Please tell us how you define a change of trend, as there are many different definitions out there. Are you using trend lines?


clmacdougall, I define a trend according to the Dow Theory. A sequence of higher highs and higher lows is an uptrend, and a sequence of lower lows is a downtrend. Furthermore, you have to know that a market moves in swings. This means that price whips several points up and down within such a trend, while it creates new significant highs/lows that must not be penetrated for the trend to remain intact. Swings in the ES are normally as big as 30 points. New highs/lows are areas at which you can adjust your stop to, so you get to secure increasingly more profits. Yes, I use trend lines, but I also watch for the aforementioned crucial highs/lows.


The best is to illustrate these words with an annotated chart that I made recently (see attachment).


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