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Alexander Elder - Trading For A Living | ||||
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free download links about online stock trading, forex, futures, stock investing, market, trading systems TREND AND TRADING RANGE Traders try to profit from changes in prices: Buy low and sell high, or sell short high and cover low. Even a quick look at a chart reveals that markets spend most of their time in trading ranges. They spend less time in trends. A trend exists when prices keep rising or falling over time. In an uptrend, each rally reaches a higher high than the preceding rally and each decline stops at a higher level than the preceding decline. In a downtrend, each decline falls to a lower low than the preceding decline and each rally stops at a lower level than the preceding rally. In a trading range, most rallies stop at about the same high and declines peter out at about the same low. A trader needs to identify trends and trading ranges. It is easier to trade during trends (Figure 20-1). It is harder to make money when prices are flat unless you write options, which requires a special skill. Trading in trends and in trading ranges calls for different tactics. When you go long in an uptrend or sell short in a downtrend, you have to give that trend the benefit of the doubt and not be shaken out easily. It pays to buckle your seat belt and hang on for as long as the trend continues. When you trade in a trading range, you have to be nimble and close out your position at the slightest sign of a reversal. Another difference in trading tactics between trends and trading ranges is the handling of strength and weakness. You have to follow strength during trends—buy in uptrends and sell short in downtrends. When prices are in a trading range, you have to do the opposite —buy weakness and sell strength. A pattern of lower bottoms and lower tops defines downtrends. Soybeans declined from November until the middle of January. Bottom 4 was lower than bottom 2, and peak 3 lower than peak 1. The break of the downtrendline at point 5 signaled the end of the downtrend. A broken downtrend can lead to either a trading range or an uptrend. The November-January downtrend has dissolved into a trading range, defined by horizontal lines drawn through the low 4 and highs 3 and 6. When the decline from high 6 stopped at a higher low 7 without reaching the bottom of the range, you could draw a preliminary uptrendline. A breakout from the range at point 8 confirmed the beginning of a new uptrend. At the right edge of the chart, prices are hovering just above their uptrendline. It is a buying opportunity because the trend is up. The downside risk of a trade can be limited by placing a stop either below the latest low or below the trendline. Notice that daily trading ranges (the distances from highs to lows) are relatively narrow. This is typical of a healthy trend. Trends often end after several wide-range days-a sign of blowoff action. Mass Psychology An uptrend emerges when bulls are stronger than bears and their buying forces prices up. If bears manage to push prices down, bulls return in force, break the decline, and force prices to a new high. Downtrends occur when bears are stronger and their selling pushes markets down. When a flurry of buying lifts prices, bears sell short into that rally, stop it, and send prices to new lows. When bulls and bears are equally strong or weak, prices stay in a trading range. When bulls manage to push prices up, bears sell short into that rally and prices fall. Bargain hunters step in and break the decline; bears cover shorts, their buying fuels a minor rally, and the cycle repeats. A trading range is like a fight between two equally strong gangs. They push one another back and forth on a street corner but neither can control the turf. A trend is like a fight where a stronger gang chases the weaker gang down the street. Every once in a while the weaker gang stops and puts up a fight but then is forced to turn and run again. Prices in trading ranges go nowhere, just as crowds spend most of their time in aimless milling. Markets spend more time in trading ranges than in trends because aimlessness is more common among people than purposeful action. When a crowd becomes agitated, it surges and creates a trend. Crowds do not stay excited for long —they go back to meandering. Professionals tend to give the benefit of the doubt to trading ranges. The Hard Right Edge Identifying trends and trading ranges is one of the hardest tasks in technical analysis. It is easy to find them in the middle of a chart, but the closer you get to the right edge, the harder it gets. Trends and trading ranges clearly stand out on old charts. Experts show those charts at seminars and make it seem easy to catch trends. Trouble is, your broker does not allow you to trade in the middle of the chart. He says you must make your trading decisions at the hard right edge of the chart! The past is fixed and easy to analyze. The future is fluid and uncertain. By the time you identify a trend, a good chunk of it is gone. Nobody rings a bell when a trend dissolves into a trading range. By the time you recognize that change, you will lose some money trying to trade as if the market was still trending. Many chart patterns and indicator signals contradict one another at the right edge of the chart. You have to base your decisions on probabilities in an atmosphere of uncertainty. Most people cannot accept uncertainty. They have a strong emotional need to be right. They hang onto losing positions, waiting for the market to turn and make them whole. Trying to be right in the market is very expensive. Professional traders get out of losing trades fast. When the market deviates from your analysis, you have to cut losses without fuss or emotions. Methods and Techniques J There is no single magic method for identifying trends and trading ranges. There are several methods, and it pays to combine them. When they confirm one another, their message is reinforced. When they contradict one another, it is better to pass up a trade. • Analyze the pattern of highs and lows. When rallies keep reaching • Draw an uptrendline connecting significant recent lows and a down- A significant high or low on a daily chart is the highest high or the lowest low for at least a week. As you study charts, you become better at identifying those points. Technical analysis is partly a science and partly an art. • Plot a 13-day or longer exponential moving average (see Section 25). • Several market indicators, such as MACD (see Section 26) and the The most important message of a trendline is the direction of its slope. When the slope is up, trade that market from the long side. When the slope is down, trade that market from the short side. The uptrendline connecting bottoms 1 and 2 identifies an uptrend. It tells you to trade heating oil only from the long side. Notice that sometimes prices break their uptrendline but later pull back to it from below (3). This is a superb shorting opportunity. This happens again at point 7, where prices rise to their old uptrendline after breaking it. When you trade in the direction of the trendline, you are usually trading in the direction of the market tide. At the right edge of the chart, you need to look for a shorting opportunity because the trend is down. Do not sell short immediately, because prices are too far below their down-trendline and your stop would have to be too wide. It is essential to wait for trades with a good risk/reward ratio. Patience is a virtue for a trader. Trade or Wait When you identify an uptrend and decide to buy, you have to decide whether to buy immediately or wait for a dip. If you buy fast, you get in gear with the trend, but your stops are likely to be farther away and you risk more. If you wait for a dip, you will risk less but will have four groups of com- petitors: longs who want to add to their positions, shorts who want to get out even, traders who never bought, and traders who sold too early but are eager to buy. The waiting area for a pullback is very crowded! Markets are not known for their charity, and a deep pullback may well signal the beginning of a reversal. This reasoning also applies to downtrends. Waiting for pull-backs while a trend is gathering steam is an amateur's game. If the market is in a trading range and you are waiting for a breakout, you have to decide whether to buy in anticipation of a breakout, during a breakout, or on a pullback after a valid breakout. If you trade multiple positions, you can buy a third in anticipation, a third on a breakout, and a third on a pullback. Whatever method you use, there is one money management rule that will keep you out of the riskiest trades. The distance from the entry point to the level of a protective stop should never be more than 2 percent of your account equity (see Chapter 10). No matter how attractive a trade is, pass it up if it requires a wider stop. Money management tactics are different in trends and trading ranges. It pays to put on a smaller position in a trend but use a wider stop. Then you will be less likely to get shaken out by reactions while you keep risk under control. You may put on a bigger position in a trading range but use a tighter stop. Finding good entry points is extremely important in trading ranges. You have to be very precise because the profit potential is so limited. A trend is more forgiving of a sloppy entry, as long as you trade in the direction of the trend. Old traders chuckle: "Do not confuse brains with a bull market." When you cannot tell whether the market is in a trend or in a trading range, remember that professionals give the benefit of the doubt to trading ranges. If you are not sure, stand aside. Professionals love trading ranges because they can slide in and out of positions with little risk of being impaled on a trend. Since they pay low or no commissions and suffer little slippage, it is profitable for them to trade in gently fluctuating markets. Those of us who trade away from the floor are better off trying to catch trends. You can trade less frequently during trends, and your account suffers less from commissions and slippage. hourly and look for trades on daily charts. With their attention fixed on daily or hourly charts, trends from other timeframes, such as weekly or 10-minute trends, keep sneaking up on them and wreaking havoc with their plans. Markets exist in several timeframes simultaneously (see Section 36). They exist on a 10-minute chart, an hourly chart, a daily chart, a weekly chart, and any other chart. The market may look like a buy on a daily chart but a sell on a weekly chart, and vice versa (Figure 20-3). The signals in different timeframes of the same market often contradict one another. Which of them will you follow? When you are in doubt about a trend, step back and examine the charts in a timeframe that is larger than the one you are trying to trade. This search for a greater perspective is one of the key principles of the Triple Screen trading system (see Section 43). A losing trader often thinks he would be better off if he had a real-time quote machine on his desk. One of the universal fantasies of losers is that they would be winners if they could get their data faster and focused on a shorter timeframe. But they lose money even faster with a quote system! When that happens, some losers say they would be better off trading right on the exchange floor, without any delay for data transmission. But more than half of floor traders wash out in their first year; being in the middle of the action does not do losers any good. The conflicting signals in different timeframes of the same market are one of the great puzzles in market analysis. What looks like a trend on a daily chart may show up as a blip on a flat weekly chart. What looks like a flat trading range on a daily chart shows rich uptrends and downtrends on an hourly chart, and so on. When professionals are in doubt, they look at the big picture, but amateurs focus on the short-term charts. |
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