In-depth Analysis

Right, wrong or just profitable?

I found myself in the middle of a philosophical conversation earlier this week as a trader in one of the chat groups I belong to, cursed the Dax and the Nasdaq 100 which had moved completely against his expectations and his positions.

I suggested a reason for the move higher in the Nasdaq.

However, we were at a bit of a loss, in more ways than one, when it came to explaining the move higher in the Dax. Apart from the obvious cliche of more buyers than sellers of course.

I took the conversation in a different direction asking whether it mattered why it had happened? And whether that was more important than the fact that it had?

I took the view that wanting to know why and trying to figure it out was just so much wasted energy that pandered to our subconscious desire to create a framework around our lives, that provides us with a sense of control, when in fact the world is largely random.

Even if we did find an answer or narrative that appeared to explain why the Dax rose, we would have no way of knowing if it was correct. Simply because we could never know the intentions, mindset, and actions of the Dax trading crowd at a given point in time, there are just too many variables.

Does that mean that we should give up trying to understand and explain the markets then?

No, not entirely, but as traders, it probably shouldn’t be our priority.

Instead, we should be focusing on our risk, money management and trading in the right direction, more often than not.

I say that because it’s trading PnLs that ultimately tell us whether we have got it right.

Do we have more money at the end of the day, week, month, and year than we started with? Were we consistent, and regularly making money?

Or did we strike it lucky a few times, and then live off the reputation of those trades for the rest of the period?

Being a trader often involves introspection and asking and answering some hard questions about ourselves.

The good news is that there are ways to remove this emotional burden and the constant need to know why, from trading.

The even better news is that they are well established and appear to work.

The most obvious solution is to become a trend follower, literally waiting for the market to start a new trend or end an existing one. And then, joining the new trend and staying with it until it finishes or fades away.

Trend following was the basis for one of the most famous experiments in trading when, in 1983 Richard Dennis bet his business partner, Bill Eckhardt, that anyone could be taught to trade.

Dennis advertised for trainees with no experience needed. He recruited 14 “wannabe” traders or Turtles as they were nicknamed. Many of whom would go on to become highly successful traders in their own right.

What was the key to the Turtle’s success?

Well, Richard Dennis, who had traded $5,000 into a pot of $100 million in his career, taught them to follow both trends and rules. In short, they learnt to trade momentum and manage their money and their risk.

They were systematic traders, they didn’t try to work out why something was happening, just that it was.

An uptrend is defined by technical analysts as a series of higher highs and higher lows. Whilst a downtrend can be thought of as a series of lower highs and lower lows.

The ebb and flow of these types of movement combine to create what is known as price action and we can use charts to track and visualise this.

The chart above is a candlestick chart of the USATEC Index, that tracks the performance of 100 of the largest US technology companies. It’s a 12-month chart with a daily time frame and I have added 20 and 50-period moving averages.

On the right-hand side of the chart, I have highlighted what’s known as a bullish engulfing pattern that was posted on March 15th. That pattern in the yellow ellipse, occurred when the bullish green candle engulfed or enveloped both the low and high of the previous candle, (a bearish red candle as it happens) marking the end of a downtrend in the index that had begun on January 4th and lasted until March 14th.

The engulfing pattern on the 15th of March announced that the downtrend was very poorly and the higher open and subsequent higher high, seen on the 16th confirmed its demise and the birth of a new uptrend.

An uptrend that ultimately lasted for more than 1800 index points and which was confirmed a few days later, as the 20-day MA line in orange, crossed up through the slower moving 50-day line, shown in green.

It would be great to know why the USATEC index “turned turtle” then rose sharply in the opposite direction in mid-March, but it would have been even better to have spotted the trend change and to have ridden that new trend for as long as we could.

 

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