Price trends: There is more than just up and down!
One of the biggest challenges people face as they attempt to make decisions about the markets is which way the price trend is heading. But this is only part of the story. Much more important than defining up and down trends is the ability to define a sideways market. Why? Because they can occur as often as 70% of the time.
Defining Price trends or the story so far
Ask someone which way the Price trends are going and they will generally take one of two approaches. They will either wimp out and say that there are a lot of factors which need to be considered in determining the trend’s direction, or they will simply give a direction. When challenged to support their belief, often they stumble around in the world of generalities rather than being specific. They can’t define it.
While there are almost as many variations on the concept of defining a price trend as there are people in the markets, you, as a trader/investor, need to have some idea of what constitutes a price trend.
Some of the ideas different people use are
- Making higher tops and higher bottoms, or
- Lower tops and lower bottoms
- Staying above/below a confirmed trend line
- Staying above/below a moving average
- Having an indicator, such as ADX above a certain value
And this, of course, extends to defining when the Price trends are broken.
What about Random Walk?
Some would say that since the marketplace is a random walk, then knowing the direction of the price trend, as such, is irrelevant. A colleague of mine performed studies testing trading system after system. Most failed miserably. The results showed more often than not that a random entry and a random exit, with sound money management, often make more money that most other systems. This could mean that there is no point in trying to pick the direction of the market. What it also points out is the importance of money management, but I’ll leave that for another issue.
Possibly the random walk approach is a reasonable position to take. In this way, you simply go with the flow. You jump into the stream, as the cliche goes, and simply get carried along with the current. The challenge I want you to consider is that the river and the current may not be going in the direction you want to go or thought you were going. Therefore it may be handy to have some sort of litmus test for checking the current.
Differing time frames
A common question is “how do I combine time frames?” “Supportively,” is the short answer. Many use the aquatic example where the long term trend is viewed as the tide, the medium term is compared to a wave and the short term Price trends are the ripples.
The goal is to get in on a ripple that piggybacks a wave on a rising tide. The catch is the ripples often seem like treacherous surf and we drown. This could be money management raising its head again?
One key to this is to make sure you are looking at the right chart to make the trend decision. In bar charting terms this may mean that you use a daily chart for the daily term, a weekly for the weekly trend and a monthly for the monthly trend. What you don’t do is attempt to determine the long-term (monthly) trend off the daily chart.
Sideways markets or ‘the rub’
Ray also raised another interesting question. One that although I had an answer for, I had not thought through in sufficient detail.
“How do you define a sideways market?” Here are two ideas to get you thinking. Firstly if a market spends a lot of time in a sideways movement, and since the average is 70%, it is important to know what a sideways market is. Secondly, consider the values of recognizing when a sideways movement is beginning or possibly ending.
A broad definition of a sideways market is when the market fails to change direction or confirm a new direction. One of the most important words in any sort of analysis is the word confirm.
There are a lot of people who are involved in the markets and they have their own opinions. Those opinions may cause you to change yours. I would suggest that knowledge and understanding are the best shark repellents.
Consider closely how you define a trend, or just as importantly, how do you define the absence of a trend?