Several famous clichés are tied to the capital market: “When it rains, everyone gets wet,” “Only when the tide goes out do you discover who’s been swimming naked,” and “Buy the rumor, sell the news.”
But one important cliché describes the most important rule in stock trading: “The trend is your friend.”
What does this mean? It means that you should always day trade in the direction of the trend, and only in the direction of the trend. Accompany it and actualize it as long as there are no signs of its ending. The more careful you are about integrating trends, the better off you will be.
The Trend is Your Friend (as Long as it Comes in a Series of Highs and Lows)
The trend is the direction that a single stock or the direction of the market (that is, the S&P 500 Index) is taking. Because the market, like a meandering river, never moves in a straight line but always zigzags, the trend is structured from a series of highs and lows.
- An upward trend is marked by a series of highs and lows in which each low is nonetheless higher than the previous one and each high is higher than the previous one. This series is defined by higher highs and higher lows.
- A downward trend is marked by a series of highs and lows in which each low is lower than the previous one and each high is also lower than the previous one. This series is defined by lower highs and lower lows.
For example, in the chart below, we see three rising lows and four rising highs. This is a clear upward trend. Notice that the fifth high is lower than the fourth. Does this indicate that the uptrend has stopped? No, but it definitely gives cause to watch for changes.
Is there any importance to the time intervals between each high and low? No. The interval at which you trade is the determining factor. For example “swing” traders who want to hold a stock for one or more days will look for the trend on the daily chart (in which each candle represents one day). Long-term investors will generally ride trends based on weekly charts (in which each candle represents one week), and intraday traders will identify and buy stocks over intraday trends based on five-minute candles.
The Advantage of the Trend Increases Chances of Day Trading Success
Live trading with the trend allows us to long (buy) strong stocks that are rising, and to short weak stocks that are dropping. In this way, we preserve the advantage of the trend and increase our chances of success. The perfect trade occurs when we buy or short a stock with a clear trend, the sector in which the company operates shows an identical trend, and the overall market shows the same trend.
Buying a stock on a downward trend, or selling one on an upward trend, is like swimming against the current of a surging river: there’s little chance that you will reach your target, and, even if you do, you’ll be exhausted.
It is equally challenging to profit when the market holds steady, moving neither up nor down. A series of similar highs and similar lows creates this trendless movement. In the trading room, we often describe this situation as “moving sideways” or “moving in the range.” Professional day traders do not trade during sideways movement, but wait for a clear up or down trend. Avoiding any action is sometimes the best step to take. Over time, you’ll discover that during sideways markets, you will do better when you do nothing. If market conditions do not allow you to join a clear trend, don’t join. In other words, not joining means not losing money.