The Subtle Differences in Trend Following Indicators

Can I tell you my worst nightmare?

I am holding a good trade and suddenly it reverses and takes out the low of the previous candle. Like a good trader I exit only to watch the buyers come back in and bid the stock to new highs. I made a little but it’s still going higher.

Mind if I tell you another one?

This time I change systems to learn from my premature exit. I decide to use a combination of moving averages so I can hold the good trades longer. The plan is to reduce market noise or the significance of a pull-back in price action. The computers won’t get me this time.

I was wrong. A normal retracement starts and I hold like a good soldier. Giving back profits I refuse to let go because the fast moving average is still above the slow. The trade is still technically valid. Before I can say moving average convergence divergence (MACD) the trade turns into a small loser. I promptly go back to the drawing board to see what I did wrong.

After a few days the answer is I did nothing wrong. I followed the plan both trades but now I am confused. Candlesticks, indicators or moving averages. Which one is the “right one?”

Which Technical Tools are Correct?

The problem you need to address when developing your charting strategy is synergy and edge.

You need synergy among charts that clearly define a trend versus an entry. And never mix the two. It is imperative to know how you define a trend and how you define your entries and exits.

You can use candlesticks, moving averages or stochastics for trends or entries but you can’t use them in the same time frame. Your trend indicator can’t be the same time frame as your entry indicator or you will lack clarity and you will hesitate. You will end up exiting good trades too soon or holding trades too long as in the two examples above.

The second part of the equation is edge.

In both trade illustrations I was focused on the money the exit. There is nothing wrong with this, it is good trading to be disciplined (although focusing on the money is not a good habit).

The challenge to overcome is one of quality. All trades are not equal. Some should be allowed extra room to breathe and others should be managed tightly. The examples were not fully given context. You must give a rating to the quality of the idea. Better ideas should be held longer. We have no idea which of the above ideas were worth holding.

Defining your Trend

There is nothing inherently right or wrong about choosing a moving average system or a multiple candlestick/multiple time frame method. The key is to be definitive in your selection. The less conviction you have about the indicators the more you will hesitate.

If you believe the system “works” but you continue to hesitate this means you don’t believe you will follow the rules. The problem is in you not the markets.

Choose one and decide if holding longer is the plan (moving averages) or if the most recent price action will be the edge (candlesticks).

Once you have conviction the two trade examples will be seen differently and review differently. Through the eyes of the system and the edge. Not through the eyes of the result of individual trades.

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