The use of Trend Following techniques has its supporters as well as its critics. I feel that the best stocks, Indexes, or futures contracts to use Trend Trading techniques are volatile markets that are sensitive to change. The other time that Trend Following works well is after crashes in markets as they recover from an extreme drop. Forced selling causes an opportunity that you do not see in a stable, well balanced market. The current recovery that started in March of 2009 is an example.
At the end of an up trend, investors are most bullish and at the end of a down trend they have the greatest pessimism on the asset. Too often the trends in price, earnings, sales and other metrics are projected higher and higher without any real evidence that the same performance of the past can be repeated for any extended time into the future.
Trend following techniques have poor predictive ability. It tends to result in trading errors at points of overvaluation and undervaluation in markets. This can be said about the management of a company or the current state of the economy. A good economy that increases in growth by 4-5% a year for several years is not necessarily an indication that the same growth rate will continue.
The fundamental factors driving prices higher or lower will eventually change. If stock prices went up 8% a year as some base their financial planning, the exponential rise in prices would surely be in a bubble condition.
We see people chasing the hot stock or sector and see that sector continue to rise and feel that last months huge gains should be repeated again month after month.
The goal in trend trading is to stay with the trend as long as possible, yet realizing that you will not be able to get the top exit price. You can try getting out early with the approach of not being a pig about the profits. All too often, a trader then sees prices continue to rise and is unable to find an appropriate entry point back into the trade. I believe it is better to let the profits run, know that you will not get the top price, and exit after a clear top has been made in the trade.
The fundamental analyst may stay too long waiting for a turn in the earnings or some other fundamental factor to be apparent. Time after time we see fundamental analysts reducing their price estimates on a stock after the company misses earnings. The price chart give clues before the release as prices were declining into the announcement.
Trend Trading is reactive, not predictive. Are the current market conditions in a Trend that will continue higher, only to fall again? Yes, I think so. In the meantime, since I do not know when that top will occur, I will sit back and follow the Trend.
We track the performance of various Trend Following Trading Systems.
For Nightly Daily Trend Trading Signals, visit www.seleznovcapitaladvisors.com