Most market participants consider themselves to be "investors." But if you look at a list of the really big winners on Wall Street, you will see that most of those who make big profits, list themselves as "traders."
By "big profits" we mean doing better than the S&P 500 Index or Nasdaq 100 Index by a substantial margin over any three-year period.
"Investors" put their money into stocks, real estate, etc., under the assumption that over time, the underlying investment will increase in value, and the investment will be profitable.
Typically, investors do not have a plan for what to do if the investment decreases in value. They hold onto the investment in hopes it will bounce back and again become a winner.
Investors anticipate declining markets with fear and anxiety, but unfortunately, they usually do not plan ahead of time how they will respond to them. When faced with a declining (bear) market, they hold their positions and continue to lose.
We all know investors. In many cases it was us before we realized how dangerous buy-and-hold investing could be to our savings.
Investors often have some knowledge of trading. But that knowledge is tainted by how it is all too often described in the financial press. "Trading" is risky, dangerous, foolish, bad, involves a great deal of work, etc. On the other hand "investing" is good, reliable and safe.
"It will take a 100% gain to make up the 2008-2009 losses for those invested in the S&P."
Investors had a taste of what buy-and-hold can do to their capital in the 2000-2002 bear market. They lost again in the 2008-2009 bear market.
But many do not realize just how far in the hole that bear market put them. The S&P 500 declined 50%. How easy is it for the markets to regain those losses?
It takes a 100% gain to make up the 50% 2008-2009 losses for those invested in the S&P. When a powerful advance is measured in 20% to 30% moves, you can easily see how long it will take to regain those huge losses.
On the other hand "traders" take a proactive approach to their investing. Traders have a defined plan and invest with one goal, to put their capital into the markets and "profit."
They "trade" with a plan that tells them what to do in any situation. When to enter and when to exit. They never allow large losses.
Being a trader does not mean you must move in and out of the markets frequently. This is a common misconception. A trader simply is one who has a plan for entering and exiting. They know what to do if their trade goes against them, and they know what to do when their trade is profitable.
Some traders go short (take bearish positions) as well as long (bullish) positions. Some are unable to go short, or they find short positions to be uncomfortable. Probably the majority of traders do not ever take short positions.
But traders "do" have a plan. This is where they differ from investors.
Every Trader Needs A Trend
If you think about it, you will quickly realize every trader needs a trend to be successful.
No matter what trading method is used, whether it is pattern trading, swing trading, long term buy-and-hold investing, fundamental analysis, technical analysis, buying or selling on news events, IPOs, splits, you name it. If the stock or mutual fund does not trend in the required direction after the trade is made, you cannot be profitable.
This also applies to all asset classes. Stocks, bonds, currencies, commodities. You must have a trend to profit.
Putting Trader & Trend Together
There are two major camps when it comes to deciding what method to use to plan a trade. There are those who follow a fundamental analysis approach and those who follow a technical analysis approach.
Traders use both methods to "forecast" future market direction. If combined with an exit strategy, either can be successful, but debate has raged for 30 years over which is the most successful strategy, as well as whether either method truly "outperforms" the markets over time.
Some very astute market players have said that both fundamental and technical analysis approaches, though they can be profitable, usually are "no more profitable than an index fund."
There is a scary thought. All that work when an index fund could do as well?
"Price is always right. If prices are moving up, the markets are advancing. Down and the markets are declining."
But there is another approach that is almost never discussed. Many hugely successful traders use it though the financial press seldom mentions it. In fact, many who use it are very quiet about their successes. They do not try to publicly prove themselves right, they just trade and make money.
This approach is the use of price to determine trends. Price does not forecast and it does not predict. Price is always right. If prices are moving up, the markets are advancing. Down and the markets are declining.
At FibTimer we are "trend followers." We respond to what "is" happening instead of predicting or forecasting what might happen. We "follow" price and allow the changes in price to tell us "when" to enter or exit a position.
Using price to determine trend does not allow trend traders to enter at the exact bottom, or to exit at the exact top. In fact, trend traders do not try to forecast the market, but instead let the market tell them when to trade and in what direction.
Trend traders wait patiently for prices to tell them a trend has begun. Then they jump on board. If the trend fails, they exit quickly to control losses. Price tells them when to enter "and" when to exit. If the trend continues, trend traders have no predetermined profit goal. They stay with the trend until it reverses.
Cutting losses quickly and staying with a trend until it ends is how trend traders realize huge profits in the financial markets. The financial markets are trending "about" 80% of the time. That means trend traders are profitable 80% of the time. During the other 20% trend traders keep losses very small so that they are ready when the next trend starts.
This does not mean 80% of their trades are winners, just that they are in the plus column for that 80%. If you have three losing trades of 2% and one winning trade of 18% in a year, you finish with a 12% gain, even though most trades were losers. This fits the old saying, "cut your losses short and let your winners run."
Remember that "price" is determined by millions of investors and traders.
By using price, trend traders take advantage of the combined wisdom of millions of investors and traders to trade a successful and profitable market timing strategy.
Yes, it takes patience to be a successful trend trader. Yes, it takes discipline to follow the strategy and make the trades, which many times go against the prevailing wisdom. This is true of "all" winning market strategies.
But trend traders who use price to determine trends have been quietly "beating" the markets for many years. They will quietly continue to do so for many more.