Cliches are boring but also true - “the trend is your friend” is the most frequent phrase you’ll hear when it comes to trading. So why aren’t more traders following it? Trading expert David Jones explains some of the risks and mistakes that are made in real trading.
Let’s start with the pure technical definition of what a trend is. The textbooks state that “A trending market is one in which price is generally moving in one direction”. Simple enough but how do you identify it? The consensus is that when drawing a trend line you need at least two points to form it and a third to confirm it. Anything more than three points is considered a reliable trend but the more points there are, the more likely it is that the trend is approaching its end.
But even with this relatively easy definition it’s hard for many traders to stick to it. This is where psychology comes in and influences trading decisions. A slight pullback resulting in a negative result for an open trade has a strong effect on our perception of risk and causes fear. Fear then causes a flight or fight response - flight equaling a closing of the position with a loss, fight meaning an increase in the position size, a defiance of what is happening and digging in.
Both are of course wrong, as the initial judgement was made in a stress free situation and the initial analysis of the trend, as well as your position size were determined through research with the lowest level of emotion. This is one of the mistakes traders make not only when trading trends but in general.
David discusses some other important points when it comes to trends, namely that they don’t go on forever and shouldn’t be trusted to do so. He also shows us some real examples on actual charts, so that you can see that the real markets aren’t always complying with theory but there are ways to develop an approach to determining trends.