Trend Following: May it be your friend or enemy.

confused

To the  average investor the stock market can seem complicated and confusing.  Stocks can go up or down for no apparent  reason. Stock A reports great earnings but  the stock plummets.  The price of oil  drops and the inflation report is tame but the major stock market indexes  dive.  Stock B reports terrible earnings  but the stock rallies.  When it comes right down to it, the reason why stock prices are going up or down  seems to be anybody’s guess.  You might  as well try to read tea leaves.

Mature man reading newspaper on toilet, side view, low section

This may  sound like ‘financial heresy’ but I really don’t care why stock prices move up  or down.  Highly paid analysts  would have us believe that a company’s fundamentals drive stock prices.  Yet how many times have you seen the stock of  companies with good fundamentals crash while those with terrible fundamentals  soar?  But none of that matters for one  simple reason…because at the end of the day, if there are more shares being  bought than sold then the price of the stock will go up.  And, if there are more shares being sold than  bought, then the price of the stock will go down.  It’s just that simple.  Everything else is just noise.

To make  real money in the market you don’t need to know why a stock price rises or  falls, you just need to know in advance which way it’s most likely to go.  If you can quantitatively measure the buying  and selling pressure of a stock then you will know in advance whether the price  is likely to rally or decline.

Successful trading can be reduced to  two simple rules:

  1. Buy investments if the buying  pressure exceeds the selling pressure
  2. Sell investments if the selling  pressure exceeds the buying pressure

The best  way to measure buying and selling pressure is to track the price trend of the  daily closing price of a stock.  If the  daily closing price of a stock is increasing then the buying pressure is  exceeding selling pressure and the stock should be bought.  If the daily closing price of a stock is  decreasing then the selling pressure is exceeding buying pressure and the stock  should be sold.

One of the  most important rules I learned as a novice investor was that you want to  purchase a stock only if the buying pressure exceeds selling pressure as  indicated by the closing price of the stock trending up.

Trying to  profit by investing in a stock with a closing price that is trending down is  very difficult as it requires that you correctly predict when the price of the  stock will ‘bottom out’.  This is often  referred to as ‘trying to catch falling daggers’.  Buying a stock because it is cheap and then  trying to predict when a stock’s price will bottom out can be nearly impossible  to forecast correctly on a regular basis.   This ‘crystal ball’ type of approach can leave the investor in a  vulnerable position.  A safer approach  would be to wait until a stock’s closing price is in an up trend before  investing.  Patience will often pay off  handsomely if the investor is able to embrace this virtue.  A stock’s closing price movement reflects all  of the known information about a company so let the price movement of the stock  tell you when you should invest.

“He who lives by  the crystal ball soon learns to eat ground glass”   Edgar  R Fiedler

There are  hundreds of indicators available that help you pick stocks.  The more complex an indicator is, the more  difficult it is to use and the higher the probability that an error will occur.  ‘Keep it simple’ is my motto.  I try to instill this into my life as often as  possible.  I also try to translate this  philosophy into my investing.  You can  look at formulas that are complicated enough to put a man on the moon or you  can keep is simple and look at trend lines that track the closing price of a  stock.  Trend lines work and are easily  understood.  That is why I prefer to use  them.

“Life is really  simple, but men insist on making it complicated”     Confucius

The goal of  the Trend Line Indicator is to  determine whether a stock’s closing price is in an up trend or down trend.  This has to be established before you invest  in a stock.  Investing with the trend is  a basic principal that is required for successful investing.

GENTING

Rely on the Trend Instead of  Predictions

The  best time to invest in a stock is when its upward closing price trend has  already been established.  Unfortunately,  the novice investor tends to purchase ‘cheap’ stocks that are in a closing  price down trend hoping to pick the bottom of the price movement.  Stocks that are in a downward closing price  trend should be sold.  A wise investor  will look at the closing price trend for assistance as the closing price trend  will reveal in advance which way the stock price is most likely to move.  Closing price trends are not  predictions.  Buying a stock with a  closing price down trend is asking the investor to be a forecaster.

(The  following is an excerpt from John Weston’s Shoestring  Millionaire)

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