The Trend is Your Friend

Why do trends matter? Why spend your time looking at or studying trends? It is for the simple fact that money tends to follow trends. In economics you are taught about trends and their impact on capital. It is no different in looking at the stock market. Pictures are worth a thousand words is the phrase made famous by Kodak. The same could be said for looking at charts in relation to stocks or sectors of the market. Pictures don’t lie. If we were looking at a picture of the NASDAQ from 1999 through 2000 we would see an uptrend which hit a top and then breaking that trend starting a new trend to the downside. That analysis alone would have said get out of the way saving the downside pain that followed. Thus, visualizing the markets is a vital part of the investment process. It alerts you to changes in the supply/demand equation and should lead you to study and review fundamental data and assumptions. This visualization permits us to examine and monitor several sectors of the market at a time. In other words it becomes time efficient. This is important due to the sheer size of the market overall. Trends matter because they reflect the value given to a specific stock, sectors or market overall. This would lead us to the conclusion the market is always right. Too often as investors we believe the market is wrong. In other words we are right and the market is wrong. This is hard to believe since the market has no emotions or reasoning in order to develop an opinion. Could it be we, the investors, are out of sync with the market? “Don’t fight the tape” is a common phrase among investors so if you own a stock and the market is going down and taking your stock with it, the market isn’t wrong, your opinion is wrong. The trend of the market is a compilation of votes cast by shareholders everyday. They make a decision to buy, sell or hold. The universal sum of those decisions is what will decide the direction or trend of the market over time. Therefore, if you are out of sync with the trend it doesn’t matter how right you think you are. My resulting conclusion is I would rather be right for the wrong reason, than wrong for the right reason, right? If trends are that important then a fair amount of our time should be spent on trend analysis. If trends can be seen then they can be acted upon. An example I like to look at is Starbucks. Who would have believed this would have become a nationwide trend? If you were to look at a chart of the stock you would have seen the trend developing based on the rising stock price. If fundamentally stocks rise over the long term because they make money for shareholders, then Starbucks is and was successful in developing a new trend for selling coffee. Had we noticed and bought into the trend we would have done very well as an investor. Stocks are the one way we can be a trend watcher and benefit from someone else’s brilliance. Let’s break trends down into three timeframes to make communicating about them easier. First there is the long term or major trend. This is determined by the time period of say six months to several years. These are the trends investors look at primarily due to their long term time horizon for investing their money. Second is the intermediate trend. This is determined by a time period of one to six months. Often investors refer to this as a correction period in a major trend. It could be also a trend within a trend. These trends offer different types of investment opportunities for those who track them. Long term investors use them to take advantage of ‘dips’ and add to their already existing long term positions. You can also trade these intermediate trends exclusively as your approach to managing your money. Third is the short term or minor trend. The timeframe determining this trend is days to weeks, but generally less than one month. This can be referred to as a correction or consolidation of a longer term trend. Short term traders use these trends for buy and sell signals. Intermediate or long term investors could use these trends to add to positions short term or play off their longer term positions. This explanation is oversimplifying the trend process, but it gives you a good starting place for watching and tracking trends. Trends help you answer some of the most commonly asked questions about the market or stocks. If the intermediate trend is down and the question is “Should you buy?” then you can now answer the question simply – no. In a downtrend the question is, are we at the bottom? Has the trend changed? If not the answer is no; if it has the answer is yes. Wow, this could really simplify the process for many of us. Remember the trend is your friend and until it is in your favor why fight it? The key is to spot the trend and be in unison with it. Keep it simple. You can make trend analysis as simple as you like or you can introduce supporting variables such as stochastic and MACD to make it more complex. The beauty of this is you are in control of your strategy. It is not a matter of what is right or wrong; it is a matter of you developing what you want to use to make your trading/investing right for you in managing your money. It is important to note though that the more variables you introduce into the equation the more challenging the process becomes as well as demands on time management. Too many variables can also make it difficult for the stars to align and make the analysis useful. From my view, KISS (keep it simple …) is always better and makes it easier for me to take action. Add variables that add value rather than stress. Focusing on entry, exit, targets and stops is more valuable than finding the absolute top or bottom. These variables keep you out of trouble both short and long term and more importantly keep you in tune with the trend. Remember, ‘the trend is your friend.’