Trends: Do they Even Exist?

Jun 18, 2007: 11:53 AM CST

I read a post from StockBee which discusses a recent short exchange between a trader and Ed Seykota, a famous trend-following advocate.

Seykota responds:

“… trends do not exist.

 

Like the past and the future, a trend is merely an idea. There is no such thing in nature.

 

  • Trend is an idea about the overall average historical direction of prices;
  • trend is a convenient way to view history;
  • trends do not indicate the direction of prices in the moment of now, or even exist in the moment of now.

 

Furthermore, The methods you use to define trend (to view history) are entirely up to you, so you get to define trend any way you wish; everyone may have a different idea of “the” trend.”

 

The entire post, as well as other questions of the month can be found at Ed’s Trading Tribe.

 

I agree that each trader can define the trend as he or she wishes, but there are common simple rules that underly the basics of a trend before any complexity is added.

 

Most traders define “Trend” as a series of higher highs and higher lows (vice versa for a downtrend). This implies that price ‘swings’ and experiences successive rallies and corrections, which is not the case in ‘runaway’ or creeper ‘trends.’

 

Some traders define trend as being above a certain moving average. I have read various comments which state “When the price falls below the 50 period moving average, we will be in a downtrend.” I argue with that statement, but it is valid if that is your definition and you make money using it.

 

Some traders define trend specifically with trendlines. This is valid as well if it makes money, and the trend will change when the respective trendline is broken. Some traders use a channel method to define converging or parallel trendlines.

 

Others use price-derivitive indicators such as the Average Directional Index (ADX) or DMI to define trend. As such, when the ADX reaches a predetermined level – usually 30 – then the market is in a trend environment. This works but grossly lags price and not only leaves profits on the table (entering too late) but exit signals aren’t clarified alone (you may exit too early or even too late).

 

So much of trading is trend identification and opportunity location (as well as money management). For the record, (I believe) trends do exist and “Trend” tests out best as any objective source of ‘edge’ in the market, and trend following strategies have often outperformed other strategies over the long term (no strategy is perfect).

 

Give some thought as to how you personally define trend and study how others do it and learn from them – their methods may be just as valid as yours.

 

 

 

 


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Sector Strength – June 17

Jun 17, 2007: 8:52 PM CST

Attached is a harrowing picture of the current state of what’s strong in the market over the last three months.

I am including a line chart and a bar chart to convey the point and clearly identify differences in prices:sector-lines-june-17.jpg

sector-bars-june-17.jpg

Clearly, we see that had you invested in the strong energy sector, you could have returned upwards of 14%, while no other individual sector came close (technology and industrials have risen 2% each). Keep in mind this picture is merely a snapshot of the last 65 trading days as of June 15th.

Because of interest rate yields rising, the utilities were the worst performing sector, losing almost 6%. It is a good sign for the overall market to see this, as well as th fact that the ‘defensive’ sectors (healthcare and consumer staples) suffered relatively large declines as well. This points to underlying strength in the broad market and the actions of the ‘big money’ institutional players.

It is a longer-term trend, but we seem to be nearing the late bull phase, as evidenced by the rampant strength in both interest rates/yield and energy prices – especially that of crude oil. This is no reason to bail on long positions or shift your portfolios yet, but it does serve as a general caution that defensive times may be nearing but are not here yet.

Here is a great example of why we’re seeing the sharp rise in the energy sector – it’s partly driven by rising crude oil prices, but unless you trade futures, it’s difficult to take advantage of the rally.  View this solid uptrend of Exxon-Mobil (XOM):

xom-june-17.png

As a bonus, I am attaching a short-term (30 day) picture of the recent action so that you can begin to find strong stocks in strong sectors to generate alpha. Remember that longer-term readings tend to carry more weight, but are slow to react to immediate changes that can be detected on shorter time-frames.

sector-30-day.jpg

We see a similar picture as above, but even more pronounced evidence in the strength of the underlying market (in terms of Sector Rotation Theory). This is what we would like to be seeing, as money is clearly flowing from one sector straight to another in a steady progression (money tends to flow left-to-right on the chart developed by StockCharts.com).

As always, use this as a guide to find strong stocks, or simply play swing trades or even position trades on AmEx Sector SPDRs.

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Link: Trade Like a Scientist Series

Jun 16, 2007: 8:38 PM CST

Dr. Steenbarger at TraderFeed has written a three-part (so far) series entitled “Trade Like a Scientist,” which includes insights on how to approach the markets from a structured, formal standpoint. The scientific method is standard operating procedure for any quality experiments, and experiments contribute to the known body of collective knowledge which comprises science.

Trading should be no different, then. Read over his posts and see what areas (including backtesting and pattern recognition) you could test using a more structured model and test your own hypotheses about the market.

Trade Like a Scientist Part I – The Scientific Mindset

Trade Like a Scientist Part II – Framing Individual Trades Scientifically

Trade Like a Scientist Part III – Three Common Mistakes of Traders

Should there be any updates, I will make note in this post and add the new links.

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Link: Active Trader Studies Schlumberger

Jun 15, 2007: 5:09 PM CST

Schlumberger: Funny name, powerful stock.

Even though I don’t watch “Cramer”, others inform me he has mentioned this stock various times and from my studies, the fundamentals, as well as the technical charts (regardless of what method you use) look promising.

Active Trader Blog posts a strong daily chart of SLB as well as a quick commentary on how to limit risk by using a proven, conservative (simple) options strategy.

Posting this link serves a few purposes:

  • Position traders can see an example of a covered call sale
  • Swing traders can see a nice uptrend and confirmed technical breakout
  • All traders can learn a bit from studying options and how they can enhance returns

There is a negative momentum/price swing divergence, but that’s no reason to exit – only a caution.  Notice the rhythmic price swings and the thought that we are making a new price swing high.

Study the chart and see if you can learn a few insights.

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Just a Blip in the Radar

Jun 14, 2007: 9:17 PM CST

Technically, I should be waiting until this weekend to post weekly index charts, but these look so beautiful (so far) that I couldn’t resist.

With the exception of the Nasdaq and Russel (technology & small cap respectively) the weekly charts of the Dow and S&P are making new all time highs as well as new momentum highs – positive signs. The charts are beautiful for the bulls who have been holding.

dow-w-june-14.png

nas-june-14.png

sp-w-june-14.png

rus-w-june-14.png

Remember the major economic reports tomorrow which – one TV analyst said today – could swing the Dow Up OR Down 200 points.

Here is tomorrow’s expected economic action (calendar) from Briefing.com:

briefing-june-14.jpg

It’s – of course – options expiration Friday. What a great time to be a trader!

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