Trend trading differs from trend following by the entry method. While trend following switches between long and short, trend trading tries to pick the right spot after selecting the right trend. At least this is our definition, right here and right now. So, what is the right spot?
The right entry spot is the one that allows for a convenient execution of a stop loss. That means you have to feel comfortable if you get thrown out once again. Comfort in this case comes from trust in your trading system. If you don’t want to trust a system blindly or without any reason, you must have some edge in your trading strategy.
The trading edge for using the stop loss technique has only to be small. Just a tiny percentage of price gain in your favor and the many small piranha bite losses of using stops the wrong way get mitigated to a friendly flap of a gold fish’s tail fin.
There are principally two ways to react to the very current market tide. Either buy low and cheap or buy high with the price moving in the right direction. Go against the price or go with it. The former method relies on snap back potential and the latter on the forces of a microtrend.
Buying cheap – how does it work? The statistical method waits for a pullback that does not get too far, say one standard deviation or perhaps two in an otherwise intact trend. If there is the magic of the trend force still at work, and the trend is not broken by any penetration of a line of support, a small one standard deviation pullback is viewed as just overlaid random noise.
Many traders are eager now to get relatively riskless on the trend, and that’s why this method works. Important is that the trend still looks good. Neither are averse news allowed, nor strong volume, or a price moving too fast the wrong way. In other words, the pullback must look like a caprice of the market.
Another version suitable for the stock market would be to enter into a stock position on a down-jitter induced by the index with a limit order. Tiny index movements often get amplified for volatile momentum stocks by a large factor. This is like a dynamic or virtual spread that can become really huge compared to the normal bid ask spread. Being able to make it, may be a day trading method on its own. Seen the other way round, this amplified fluttering is part of the piranha’s dentition.
Buying high in the micro-time-frame works also. This is like betting on a small trend in a larger one. At its best the small trend becomes the next larger thrust. That’s why this procyclical method is more straightforward, which is always a sign for a good system.
The procyclical version has also the psychological advantage of being more coherent. If the entry is done anticyclically, but the trading over the whole holding period is thought to be clearly procyclical, a trader has to be even more disciplined. It is easy to become confused by these two fundamentally different trading styles.
So, at least understand exactly if you use the pullback method that you are doing this to successfully execute a system based on a stop loss insured entry. Or you will not only be nibbled by piranhas but torn apart by the sharks if you miss your stop.