The Trend is Your Friend... Until it Stabs You in the Back

The trend is your friend…

You’ve heard that one before. Everyone has. Why is it so famous?

Simple: Markets trend. Period. It doesn’t matter if you’re a value investor, daytrader, swing trader, or stargazer– you can’t deny this simple truth.

Today I’m going to show you how you can use a trending market to your advantage—but also what to do when the trend isn’t cooperating. Because right now there is no trend to befriend. Just a bunch of nasty sideways chop. And it’s frustrating for traders. I’ll show you how to handle it…

Look, just because markets usually trend doesn’t mean they always trend. Everybody talks about stocks going up or down. We rarely hear any bold predictions about the market moving sideways. Not only does it make for bad TV, a sideways market also makes trading difficult.

And like I said, this is exactly the kind of crap we’ve been dealing with this year. Take a look:

RUD_Choppy_051115

Not exactly a picture-perfect trending market, eh? Nope. This year’s been all about the grind. Sure, a couple of sectors have made significant moves (biotech and energy come to mind). But overall traders and investors have been dealing with choppy stocks.

Compare this action to the market in early 2013 and you’ll see exactly what I’m talking about:

RUD_Strong_051115

The S&P 500 has gained about 2.8% so far this year. In 2013 the market was already up nearly 15% by early May. Do I have to tell you which was the easier environment to book consistent gains in? Don’t make me answer that one.

But as I’ve told you before: this sideways chop won’t last forever. And you won’t be stuck booking small losses for the rest of your trading career either. So don’t feel like you have to do something right now. Staying patient is the big psychological hurdle you have to overcome…

So your first rule for dealing with this directionless market is don’t fight it. Don’t get antsy. If the market’s not giving you a green light don’t hit the gas. Don’t load up on any big bets right now – short or long. And until we see a clear trend higher or lower all of your trades should be small-than-average position sizes!

There’s nothing wrong with buying a position half your normal size. And don’t worry if you find you’re getting stopped out of more trades than normal. Remember: we’d rather gain a little than lose a lot. Or lose a little than lose a lot. Next rule…

Ignore your feelings. Just because the market isn’t ripping higher every single week does not mean we’re in a nasty bear market. You might feel more bearish now (trust me, I struggle with this every single day) but that doesn’t mean the market is bearish. Big difference.

And don’t fall for any temporary market moves up or down just because they confirm your bias. You need to wait and see until a clear trend forms. And yes that takes discipline. If you don’t have it take up another sport. Trading’s not for you.

“It might not feel like it right now, but we’re still in a ‘buy the dips market’,” my friend Jonas Elmerraji reminds us. “I keep harping on it because market context is so critical in environments where trades are getting dragged out longer. So we’ll keep on buying high-probability trades that are likely to give us a bigger move than the rest of the market.”

Exactly.

So the best thing we can do right now is keep plugging away with the ol’ trading playbook. Yes, we’re going to get stopped out of some of our trades. And not every single idea will become a huge winner. But if we stick with our rules and stay disciplined during this choppy market we’ll come out the other side smelling like roses.

Calmer waters are ahead, I promise.

Regards,

Greg Guenthner

for The Daily Reckoning

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