There’s an old saying in the financial markets that the trend is your
friend, meaning that you will do well as long as you position your trades in
line with the current price trend. This sounds good. The only problem is that
you can never know what the current trend is; you can only know what the
trend was during some prior period. How is it possible for something you can
never know to be your friend?
Market ‘technicians’ often make comments such as “the trend for Market X
is up” and “Market Y is in a downward trend” as if they were stating facts.
They are not stating facts, they are stating assumptions that have as much
chance of being wrong as being right.
A statement such as “Market X’s trend is up” would more correctly be
worded as “I’m going to assume that Market X’s trend is up unless proven
otherwise”. The proving otherwise will generally involve the price moving
above or below a certain level, but the selection of this level is yet
another assumption and the price moving above/below any particular level will
provide no factual information about the current trend.
To further explain, let’s say that a market made a sequence of higher
highs and higher lows over a 3-month period. It can be said that during this
period the market’s trend was up. That’s a fact, since the definition of an
upward trend is a sequence of rising highs and lows. However, even if this
market has just made a new high it is not a fact that the current trend is
up, because the high that was just made could turn out to be the ultimate
high prior to the start of a downward trend. Nobody knows whether it will or
won’t be the ultimate high, but some traders will assume that it was — or was
very close to — the ultimate high and sell, while other traders will assume
that the trend is still up. The members of the first group have approximately
the same probability of being right as the members of the second group, but
many members of the second group (the trend-followers) will unequivocally
state “the trend is up”.
In the above hypothetical case, let’s assume that the first group was
right and that the price immediately started to trend downward. Most members
of the second group will have in mind price levels at which they will stop
assuming that the trend is up, but the point at which their assumption
changes could turn out to be the bottom. In other words, having wrongly
assumed that the trend was still up after the price had just peaked, they
might subsequently make the incorrect assumption that the trend has changed
from up to down at the time that it is actually changing from down to up.
The impossibility of knowing the direction of the trend in real time is
one of the reasons that the majority of trend-following traders end up losing
money. Looking from a different angle, if it were possible to KNOW the
direction of the trend in real time then every half-decent trend-follower
would generate good returns, but very few of them do generate good returns
over the long haul.
As an aside, the majority of non-trend-following traders also end up
losing money. The fact is that regardless of what method is used, trading
success over the long haul is primarily about risk management.
So, just be aware that when you read comments along the lines of “the
trend is up”, the author is not stating a fact. He is, instead, announcing an
opinion (making an assumption) that could be wrong.
