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.
About Steven Saville
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