Measure Trends Easily and Accurately
02/10/2012 12:18 pm EST
Many "simple" trend strategies may not work for most traders, warns Rob Booker, who explains how he uses a little-followed moving average to identify solid, tradable trend and countertrend set-ups.
As a trader, you’ve probably heard the terms “trend trading” and “countertrend trading,” but how do you really measure if something is in a trend objectively? Our guest today is Rob Booker to talk about that.
Rob, how can I measure a trend objectively and not just say, “Oh, it’s going up. The slope looks like it’s going up?”Â
Well, you’re definitely putting me on the spot. That’s a huge question. Here’s my simple answer.
There’s this huge argument about what a trend is and how you measure it and how you define it. Most people will measure a trend in a traditional manner. You’re familiar with this; we’re both traders. You know, they’ll draw a trend line on the chart, and if the trend line is sloping upwards, it’s an upward trend; and downwards, it’s a downward trend.Â
What we’ve all encountered in our trading careers is that’s probably not enough information to make someone rich.
If you blindly apply the Turtle Trader method, the most famous trend trading method of all time, and you just plop it onto your charts, 99% of traders can’t actually make that a profitable strategy.Â
So, the whole argument about trend trading being more popular because it’s more successful, first of all, that’s kind of a non-issue to me. I don’t really believe that.Â
Second of all, to answer your question, the simple way that I measure a trend is I’ll look for a financial instrument and see how long any financial instrument has spent away from what I call a “home base,” or its natural state, or a moving average that I use. If you’re interested in it, we can talk about that.Â
I measure the length of time that financial instrument spends away from this home base. So, I don’t really do a price-based trend measurement, but I do a time-based measurement.
And what is that moving average that you like?
What I do is I’ll take any time frame chart. Let’s just say the five-minute chart, for example, and I’ll take the 800-period simple moving average, which sounds like I’ve been smoking a whole pile of crack because some charting programs won’t even plot that.
I’ll plot the 800-period simple moving average; hardly ever moves. It doesn’t gyrate wildly in response to market volatility, and I’ll measure the length of time that a financial instrument has spent away from that.Â
If it doesn’t touch it during one bar, I’ll count a one. Then I’ll count a two if it doesn’t touch it on the next bar, and so forth.Â
When any financial instrument has gone beyond 750, so 750 daily time periods, or one-hour time periods, or for me, five-minute time periods, a trend has reached an exhaustion point measured in time regardless of how far it’s gone or the trajectory based on the length of time that it’s gone.Â
That’s when I’m starting to exit my trend trades, and I’m starting to set up countertrend trades because it’s reached a length of time that is statistically really unlikely.Â
To give you a snapshot into it, if any financial instrument—and we could pick one right off the shelf right now—has spent more than 1000 bars away from the 800-period simple moving average measured in time, that has a 3% statistical likelihood of happening. It’s almost impossibly rare.Â
When that happens, I want to be out of my trend trades, and I want to start planning those countertrend trades at that point in time.