A few weeks back, I kicked off the Intelligent Investor Series as part of my weekly commentaries. Th...
How to Spot the Year’s Best Trend Trades
06/19/2012 10:35 am EST
By following these pre-defined rules, market timers can identify and capitalize on the market’s biggest and best trend trading opportunities, writes Frank Kollar of FibTimer.com.
In the financial markets, a trend is generally understood to be the current market direction. Markets can be trending higher, trending lower, or trending sideways. But defining a trend so that it can be profitably traded is something else entirely.
Trends can obviously exist for one sector while another is going in the opposite direction, or no direction at all, and they can last for different periods of time.
Just saying that a trend consists of "rising" prices or "declining" prices is not enough. Every day is different. A trend must be clearly defined in order to be profitably traded.
And what about time frame? Are we talking about a trend on a five-minute bar chart where it could last an hour? Or is it of longer duration: days, weeks, or even years? If you are a mutual fund trader, trends lasting less than several months will be almost impossible to trade profitably.
It is easy to determine trends on an historical chart when looking at trends that have already occurred, but developing a trading strategy that will keep you on the right side of future trends is needed to profit when trend trading (market timing).
Note that we do not say market timers can "predict" the future. We are not of the crystal ball camp, which dooms many market timers to failure.
Instead, we say that trends tend to last for periods of time that make them tradable. So identifying trends, and jumping on board, is the key to profitable market timing.
Successful market timers know and use several facts about trends that give them an edge in trading them:
- While financial markets may spend time in consolidation (sideways trends), they are more often moving up or down for sustained periods of time
- A timing strategy that defines trends can be used to take advantage of continued momentum in the marketplace
- Trends tend to go higher or lower than most investors expect, so correctly identifying and trading a trend can be very profitable
- Profitable trends typically occur only once or twice a year. The rest of the time, the markets trend sideways
Because tradable trends only occur once or twice a year, market timers must be prepared to sometimes wait months before catching that one highly profitable trend.
To be consistently successful over time, market timers must have clear rules telling them when to enter, and when to exit.
- When in a sideways trend, market timers may have trades that result in small losses, or small gains. These small losses and gains must be accepted because timers must trade every identified trend change. There is no way to know ahead of time which trend will be the highly profitable one
- Market timers usually make the majority of their profits in only one or two trades a year. If you don't take every trade, you will likely miss the one that makes most of your profits
- When the markets are in a bullish or bearish trend, trading position changes may not occur for months at a time as the trend progresses. Exiting early to lock in profits can cost you dearly. The trend must be allowed to play out without making unnecessary trades because of volatile short-term conditions
- A profitable trading strategy will not allow a market timer to miss that trade!
Correctly identifying and trading financial market trends with mutual funds, ETFs, and even carefully selected stocks, is doable, and profitable, and with a well-tested trading strategy, it can achieve results far superior to buy-and-hold investing.
Market timing, when following a well-thought-out trading strategy, is actually less risky than a buy-and-hold approach. Imagine the benefit when all bear market losses are removed from the equation!
The active investing style used in FibTimer's market timing strategies (identifying and trading trends) prevents huge losses in the inevitable bear markets (or any large decline that is of substantial duration).
If bearish strategies are used in the timing strategy, declining markets actually add to profits, as they did in our Bull & Bear Protimer Strategy in 2001-2003 and 2008-2009.
Market timers, when following a well-defined and tested timing strategy that identifies market trends, will consistently beat the market over any fair time frame.
By Frank Kollar of FibTimer.com
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