Trend – The Key to Profits in Technical Analysis

Remember that profit with minimum capital risk in the securities markets is the sole objective, and technical analysis is an effective way to profit as well as to control risk. In earlier chapters, we emphasized the importance of determining and riding the directional trend in the security markets. The key to profiting in the securities market is to follow these three steps:

1. Determine, with minimum risk of error, when a trend has begun, at its earliest time and price.
2. Select and enter a position in the trend that is appropriate to the existing trend, regardless of direction (that is, trade with the trend—long in upward trends and short or in cash in downward trends).
3. Close those positions when the trend is ending.

Trending is simple in concept, but it is difficult in practice. Almost all successful mechanical trading systems that have made millions for their investors have been based on the simple concept of jumping on a trend and riding it to its inevitable end. We discuss the principles behind some of these methods later in this chapter and in following chapters.

The principal caveat, however, in technical analysis, as mentioned previously, is that although the trend concept is easy to understand, its application is difficult largely because the determination of trend and trend reversal is, in many instances, a subjective decision that depends on one’s skill and experience in the securities markets and one’s ability to control one’s own emotions. Practice and mental anguish are the background of any successful technical analyst. The most expensive education in the world is likely the money lost in incorrect, sloppy, and undisciplined decisions. All market participants make mistakes, but the regimented professionals correct theirs quickly.

When we arrive at Chapter 15, “Bar Chart Patterns,” and discuss the various price patterns that have been observed, we will note that almost all patterns are a combination of trend lines—up, down, or sideways. It is, therefore, imperative first to understand trends and trend lines. In addition, all patterns are used to either confirm that a longer trend is still in control or warn that such a trend is changing. Patterns are, therefore, not trade signals explicitly in themselves, but they are the means of taking advantage of the underlying and, perhaps, changing trends.

Source: Kirkpatrick II Charles D., Dahlquist Julie R. (2015), Technical Analysis: The Complete Resource for Financial Market Technicians, FT Press; 3rd edition.