Tim Walker
Tim Walker

Corny title, but it makes a point. Everyone has read in the Smarter Starter Pack that the “trend is your friend” and that you should trade with the trend. But do you do this? I challenge you to make a list of your trades over the last 12-months and put them in two columns – trades with the trend (Type 1) and trades looking for a change in trend (Type 2). I am certain that many of you will actually have more Type 2 trades than Type 1 trades.

Now look at the chart of any market you like and see how many times the trend has changed direction over the course of those last 12-months. Let’s use Apple (AAPL) as an example:

Chart 1 – AAPL Changes in Trend

click chart to enlarge

If you had been trading AAPL from the start of 2012, you would have wanted to be long from the beginning of the year until April. You could then be short for a month into May, after which you wanted to be long again until the September seasonal date. Apart from a sharp rally in the second half of November, you wanted to be short ever since. Notice that I haven’t placed a date at the end of the chart because there is no sign whatsoever that the trend might be changing.

Thus, over the last 12-months or more, you should not have taken more than five Type 2 trades in this stock. Now let’s take a look at the number of Type 1 trades on offer. Over the same period there were 29 ABC long and short trades! 29:5 is close enough to 6:1.

Chart 2 – AAPL Trades with the Trend

click chart to enlarge

Now go back to the summary of your own trades over the last 12-months. Did you take six times as many Type 1 trades as Type 2 trades? If you did, I strongly suspect that you were quite profitable over the period. If you didn’t make money over that period, I suspect that your ratio is somewhat askew.

Over this same period, approximately two out of three ABC trades on AAPL were profitable. So with no analysis at all, if you just took every ABC trade and averaged 2:1 reward to risk, your profits would have been very pleasing.

So what went wrong? I believe the problem lies in the desire of human beings to be right. We want to feel smart. Both W.D. Gann and David Bowden made most of their money by following the trend. They made good profits out of trading turns but the trends made the consistent money. David said that his aim was to take 50% out of each major trend on the weekly chart.

When you think of these two great traders, what comes to mind first? David calling the 1989 top or the 1991 low? Gann calling the top in 1929? Forecasting the turns is glamorous. Consider the popularity of political opinion polls. People want to know what is going to happen next. It is exciting to be the person who gets it right.

Look back to Chart 1. What about if you had missed all of those turns? How much difference would that have made to the profits on the ABC trades? The answer is none! If you look carefully at Chart 2, you will see that there were successful ABC trades after the 10 April and 18 May turns and unsuccessful trades at the other three.

So the only help that picking the turns would have given you is to avoid three unsuccessful trades and perhaps get a few successful ones in as well. Of course, this would have been great and would have increased your profits even further. However, could you limit yourself to just picking these turns or would you have picked a dozen other ones as well and lost money trying to trade against the trend?

You might have some soul searching to do. Do you want to be the glamorous trader who forecasts the next turn or the boring trader who makes all the money?

Knowledge is Power!

Tim Walker