Believe your eyes. The bleedin’ obvious is very often correct. If you want to appear all intellectual, say you turned bearish because of Occam’s Razor.
The trend is your friend – until the end. I teach this in both my Introduction and Advanced Technical Analysis courses. I have given the courses maybe one hundred times to thousands of institutional traders worldwide. It is there in my Technical Analysis for Portfolio Managers course and discussed and dissected why trends form and gather or lose momentum in my Behavioural Finance courses. Because many traders who attend my Short Term Trading Techniques are treasury, FX and derivatives traders and mean reverting types, the trend is not their friends. Indeed, it is their nemesis and they do best to recognise and avoid highly trending securities as they day trade. Strong trends are very difficult for day traders.
An essential concept to have mastered is recognising and defining the trend. Buying dips in a clear and strong trend is very profitable until a dip turns into something more – a new trend – a reversal. We learn how to recognise dips as dips and trends-changes are reversals. We learn how to master both using the trend while it lasts and not getting caught and indeed catching the trend change as it occurs. The dips are to be bought until the last one which is not.
In shorter time frames we have a lot to help us recognise dip to buy or market trend changes. We learn how to understand the messages of candle sizes, candle shadows, body sizes, the volume action, oscillator divergences. Understand these puts the odds of making a correct identification of a top or a turn much much higher.
In the longer term the analysis is often easier. The problem is believing your eyes. Can this long move up or down finally be over? It is hard to accept a change of a trend we have got used to. how difficult will it be to get bullish of energy? We are used to it going down and down. it will probably go up a lot in price while we remain sceptical.
This is very typical of the crowd psychology during a Wave 1 of a trend change. Once we have dipped but not made a new low, turned up and brokent the high of Wave 1 we have the typical power move of a Wave 3. this is the point psychology changes to bullish. Suddenly we see that there was an attempt at a new low which this time has failed. Indeed, we have started to move higher and made a new recent high. We have been going up for some time and many traders are not long. They see they have remained bearish but the price has advanced a lot already and they are not long. This is why Wave 3 is often so powerful. its is the move created by the realisation we are not going down, we are going up and we have been for some time already and I need to get long fast.While this move is complex psychosocially it is often simple graphically. Familiar patterns are formed during the change of trend: head and shoulders, double tops or bottoms and a few others. We see they graphical descriptions of the market changing its mind from bullish (or bearish) to bearish (or bullish) time and time again. This is why classical charting remains popular after decades. Our behaviour at turning points is repetitive. It is not the case of, once recognised, we change behaviour. No, we react in the same way to the same psychological stimulus time after time. Every time like it was the first time.
We technical analysts have no argument with the fact that prices are pushed about by supply and demand. We just change the names to resistance and support. We see the market move up, pushed by higher support (demand) levels. We study these levels closely. We look at their power. and how far we are pushed each zig of the zig-zags higher. We look at the zags to see how much power there is in the counter trend moves. We see how often the demand that drove us higher, when broken, can act as resistance later. We good at this. We see how sometimes the demand levels line up and we can draw a trend line and project where the price should hold in the future or where, if the demand line breaks, the demand has ended. We learn how to do these things – its is called Charting.
The techniques we learn are not complex. No Ph.D. is needed. just a brain that is accepting of patterns. most of us have this type of brains – artists, linguists, musicians particularly so. The problem is believing what you see. accept the bleedin’ obvious. I find it hard myself. emotions contrive to hinder my ability to accept what is right in front of me.
Occam’s razor is the philosophical principle that suggests, all things being equal, the simplest explanation tends to be the right one – or the bleedin’ obvious is the most likely interpretation. The S&P broke its long, thrice tested, up trend line in August of 2015. Once broken, there was a classic bounce, retest and failure. This chart should go into your album of classic chart patterns. It was simple, clear and obvious. But how many investors, analysts, traders were confident the uptrend in the S&P was over six months ago? Few I think. Maybe now, now we are so much lower.
Believe your eyes. The bleedin’ obvious is very often correct. if you want to appear all intellectual, say you turned bearish because of Occam’s razor.