What Makes Trend?

Boris Schlossberg

What is trend?

That is a deceptively complex question. As someone who almost exclusively traded counter-trend moves for the past ten years, I found the idea of defining and identifying trend to be a real challenge. Counter-trend trading is relatively easy because it’s organic. It’s a reactive strategy that is derived from the trend itself. Until trend materializes there is nothing to do and nothing to define. Once trend takes place, the counter-trend setups kick into gear.

Trend on the other hand, requires predictive rather reactive skills and therein lies the rub.

At its most basic trend is simply a continuation of price. But what causes that continuation? Certainly, news is a major catalyst. An unexpected piece of data or a casual remark by a central bank official can have price ramifications for hours and sometimes days. But news is not the only catalyst for trend. Sometimes it’s just price. A price move will take on a momentum of its own and will create trend without any new information in the market. So sometimes news creates price and sometimes price creates news.

That’s what makes trend so tricky to trade.

Counter-trend trading (which is effectively market making) is an actuarial activity. It’s based on the law of large numbers -- very much like the insurance model. Trend, on the other hand, requires the eye of a fine jeweler. Ideally, the trader needs all three components to come together -- price action, news action and sentiment. Trend is rare -- it occurs no more than 30% of the time in the market. And that is perhaps the most difficult thing about trading trend well. For a day trader like me, it’s truly a Herculean effort to maintain the patience to trade trend properly.

Still, the more I do it, the more I appreciate it. Trend, in reality, is very different from what the books and gurus tell you -- but nevertheless, it can be a very profitable strategy once you figure out how it works.

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Warren Buffett Does Not Trade Trend

Boris Schlossberg

The other day I came across an article about Warren Buffett’s office. The writer catalogued in full detail all of the knick knacks that Buffett has in what was described as “the domain of a mid-level executive in a generic corporation.” I knew that Buffett was frugal, but the fact that one of the world’s richest men still watches television on cathode ray TV really surprised me.

Yet what really caught my eye about the article was that Buffett had a picture of Ted Williams in his office. I wrote about trading like Ted Williams several years ago and it appears that Buffett is a fan of the baseball great for the very same reason that I am. As Buffett tells the writer the picture of Williams is there to remind him to “wait for the right pitch”.

If you really think about what Buffett is saying, it means that you must let price come to you. It means effectively that Buffett never trades trend. As a value investor he is always buying when everyone is selling and selling when everyone is buying. He, of course, is not alone. Almost all great investors do this including Seth Klarman whose book sits on Buffett’s desk.

Yet think about the idiotic cult of trend that pervades all retail trading. From the moment you are newbie to the very last penny that you lose from your account you are told by every paper trading guru that you “must trade with trend”. Now there is no doubt that some -- few -- traders can trade with trend successfully, but the vast majority of traders lose all their money following that useless advice.

Why?

Because trading trend puts you at a disadvantage from the moment go. You are chasing price, you are following the crowd and that strategy only works if the wave continues to swell. But hurricanes are rare and most of the time the wave crests and you just crash into the rocky bottom of unforgiving ocean wondering what you did wrong.

Currency markets -- and for that matter all capital markets -- are just like the ocean. On a day to day basis prices crest and fall and rise again. That’s why in my day trading room we trade counter-trend almost all the time. Trading counter trend by no means guarantees success. In fact, if you do what most retail traders do, which is -- add to the position and trade without a stop -- you will most certainly go bankrupt. But counter trend trading with a robust entry model and an intelligent trade management system is a much better way to day trade. It puts odds in your favor.

Just ask Warren Buffett.

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The Trend is not Your Friend

Boris Schlossberg

So there is so much to talk about this week. I could talk about how the SNB nearly destroyed the FX retail business in a matter of 24 hours. I can talk about how much fun I had in VT trading chat room where we banked so many pips that I stopped counting by end of week. I can talk about how I went from sheer elation after being on the right side of the EURCHF trade to complete panic when FXCM announced that they were basically staring into the abyss of bankruptcy to absolute relief when they found a White Knight just before the close of business on Friday.

But the most interesting thing to cross my desk this week was actually a throw away article on Marketwatch that revealed something fascinating about how money is actually made in the capital markets. In a piece titled Easy way to get rich: Buy the most hated stocks Brett Arends basically lays out the case for contrarian trading. Arends looks at 10 worst ranked stocks in the S&P 500 as named by Wall Street analysts and discovers that 100,000 invested into 10 most hated ideas every year since 2008 would have turned the portfolio into 270,000 dollars. Just investing into the broad S&P 500 you would have made 170,000 dollars.

That is a massive difference and I think it says a lot about how alpha is really generated. Don’t get me wrong. I am not arguing that the way to riches is just to blindly bet against the trend. That in fact is the way to ruin. And if you are a long term investor who really doesn’t have the time or inclination to follow the markets them the old and boring dollar cost averaging strategy of buying a fixed amount of index funds every single month come rain or shine is the absolutely best way to make your money grow. In the long run the trend does win.

But if you are a trader, the profit does not lie in the trend. Of course the obvious can sometimes be incredibly lucrative. Shorting oil as it continued to fall or selling EUR/USD as it broke 1.2000 were both great trend trades that made gobs of money. But the problem with those examples is that they are very much like lottery tickets -- incredibly seductive but utterly disappointing for 99.9% of us who try them. Just as the lottery trots out the winners and lets us vicariously wallow in their good fortune while conveniently forgetting about the millions of wasted tickets, so does the trading industry love to pull out massive multi-year charts of trend moves with very conveniently tagged labels -- if you entered here and exited here you would have made ten trillion percent!

But in reality how many people can really catch a trend? How many successful trend traders do you know? How many successful trend trades have you ever had .. IN A ROW? Yes of course you will catch an occasional big one and then most likely will spend the rest of the year giving back your profits in a series of endless retraces.

The truth of the matter is that the more I trade, the more I realize that the profit is in being in the minority. This is by no means easy to do, and it certainly doesn’t mean fading every rally or buying every dip, but it does mean that to make money consistently you need to be on the opposite side of the price because it is only at those extremes that you have a better than 50/50 chance of being right.

VT -- Making a Fortune 10 pips at a time

The VT day trading system that we use in the chat room proved that in spades this week. In the midst of some of the most vicious volatility that we’ve had in years, the rookie traders in my room managed to not only survive but to thrive by doing what was uncomfortable but ultimately profitable and the experience just served to convince me once and for all that the trend is not your friend.

Yen on Trend? – Forex Weekly Technicals 11.18-23.13

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