Is the Trend Still Your Friend?

Posted on October 30th, 2013

One of the easiest technical analysis phrases to remember is “The Trend is Your Friend”.  It rhymes and has the convenience of being right most of the time. But what defines a trend?

Here’s a snapshot of the S&P 500 from April through October 2013 and we would clearly define this as a trend. 
 Investopedia.com has the following definition of a trend

The general direction of a market or of the price of an asset. Trends can vary in length from short, to intermediate, to long term. If you can identify a trend, it can be highly profitable, because you will be able to trade with the trend.

As a general strategy, it is best to trade with trends, meaning that if the general trend of the market is headed up, you should be very cautious about taking any positions that rely on the trend going in the opposite direction.


The site also goes on to explain trading a trend and what is trend trading
 
Investopedia explains 'Trend Trading'

A trading strategy that attempts to capture gains through the analysis of an asset's momentum in a particular direction. The trend trader enters into a long position when a stock is trending upward (successively higher highs). Conversely, a short position is taken when the stock is in a down trend (successively lower highs).

This strategy assumes that the present direction of the stock will continue into the future. It can be used by short-, intermediate- or long-term traders. Regardless of their chosen time frame, traders will remain in their position until they believe the trend has reversed - but reversal may occur at different times for each time frame.
 
We bring this topic up because many clients have expressed feelings that this market has gone too far too fast. They are worried about a pull back and eventually have to pay the price of a Fed-inflated frenzy.  I can’t blame them, the trader in me (my inner guru) agrees that most of the near-term upside is in. Even basing my opinion on the chart above feels like at least a 4-5% retracement is coming soon.
 
The thing about trend trading/investing is that the trend works for you only as long as it exists. Of course…duh, but telling how long the trend is in place is another thing. One lesser quoted rule of thumb to use is to make your projections based on your investing time horizon. For example, if you’re running a swing trade strategy, keep the length of time to weeks, not years. If you’re managing your long term money, then look at multiple years vs. just one year at a time.
 
In that light, this market has been in an uptrend with higher highs and lower lows since March 2009. In June 2009, the S&P broke higher than its previous high and has been in that pattern ever since. So while many are in the camp that this year has been too much too fast, on the broad scale, it is following the trend we’ve seen over the last 4 ½ years.
 
If we had to speculate, this current bull trend would no longer be a trend when/if the market pulled back to somewhere below 1350. That is a long 23% away from our current levels, but is consistent with the definition or magnitude of a bear market. We preach hedging against such moves over and over and continue to do so. Giving up 23% or more would wipe out much of the gains of the last two years. No reason to give that back without a fight.
 
Bottom line, despite short term tops and minor swings, this long-term bull market is still going strong. If you want to use your inner guru and make some short-term trades, go for it, but overall stay in this bull market with your hedges in place. No need to time the big swings. Let your hedges protect you from emotional decisions on that slice of your assets.


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