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Why Trend Following Works

Why Trend Following WorksThere is a wonderful quote by the great Jesse Livermore that I really like:

‘I absolutely believe that price movement patterns are being repeated. They are recurring patterns that appear over and over, with slight variations. This is because markets are driven by humans, and human nature never changes.’

Two of the strongest emotions aligned to human nature are FEAR and GREED.

Fear is the most powerful. As reflected on price charts when uptrends reverse.

The speed of the initial downside move is often lightning fast. Which is in complete contrast to the less volatile step by step progress seen in bull markets.

Up via the stairs and down via the escalator.

In simple terms, trend following works because for centuries human emotions have not changed. Which means price patterns are going to repeat over and over again.

Lets look at some trading principles that will always hold you in good stead as a trend follower.

1) The markets are never too high to go long, or too low to go short. How many times have you seen a market with overbought indicators continue on higher? And how often have you seen a market or stock with well oversold indicators, continue to head lower? The fact is that when a strong trend becomes established, it can remain in play for extended periods of time.

2) Always follow price action. If you don’t follow price action, you will start trying to make predictions. And as soon as you start doing this you are in all sorts of trouble. You’ll start moving your stop around because you want to be right. Or you might start averaging into your losses to make yourself feel better. Even worse you may start to revenge trade.

3) Avoid profit targets. Profit targets are great when markets are not trending. You can take profits aligned to pattern targets for example. Or you may trade from the bottom of an established range up to the top of the range. Yet if a trend is already well established, you can lose a big chunk of potential profits by exiting at predefined targets.

4) Consider trading other markets to increase your capacity to trade trends. For the most part, markets spend more time going sideways than trending. Yet while stocks may be doing this at any given moment, futures markets may be trending solidly. Whether it be metals, FOREX, or agricultural markets such as wheat or soybeans. So if you want to be consistently following trending opportunities, consider adding a variety of markets into your trading universe.

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