As I verbalize amongst traders, I disclose a mutual error that is responsible for quite a few losses: the confusion betwixt style trading together with momentum trading. They are non the same thing. Traders who fright missing out on a trending displace together with chase pull or weakness oft larn whipsawed together with stopped out.
Let’s define our terms:
An property that is trending is making higher highs (lower lows) together with higher lows (lower highs) during a given lookback period. If yous imagine a regression trouble for cost every bit a percentage of time, the trouble would live on the trendline together with at that spot would live on a noticeable positive or negative gradient over that lookback period.
An property that is trading amongst momentum tends to driblet dead along inwards the management inwards which it has been trading. Strength tends to live on followed past times strength; weakness past times weakness. Think of that regression trouble that is the best gibe for a given trend. If cost oscillates widely approximately that trouble (i.e., the gibe is non great), this is because the trending property is non trading amongst momentum. When cost is strong, it tends to fade together with vice versa. A trouble that is a rattling skilful gibe suggests momentum inwards the management of the trend.
When traders assert that at that spot is a style together with and thus purchase pull (or sells weakness) to ride the trend, they are assuming that the style likewise displays momentum. That ain’t necessarily so. Buying pull inwards an uptrend together with selling weakness inwards a downtrend is a nifty agency to underperform inwards a style marketplace position that is non a momentum one.
Let’s larn to the fantabulous Paststat site for a duet of illustrations. A technical indicator is a useful together with familiar stair out of cost pull together with weakness. If an property shows momentum effects, it should demonstrate important pull next high indicator readings together with important weakness next depression readings. Different indicators contain dissimilar lookback periods, thus a hold off at several is useful if nosotros desire to guess momentum over differing fourth dimension periods.
To start, let’s tell nosotros purchase SPY when it closes higher upwards its upper Bollinger Band together with agree for 5 trading days. Over the past times 3 years, this has resulted inwards xl trades. Of those, 24 direct keep been winners together with sixteen losers for an average hit of +.04% together with a profits element of 1.13. Meh. No distinctive upside border to buying strength, simply likewise no important weakness. This fits amongst my research: when cost pull occurs amongst positive breadth thrust together with elevated momentum, at that spot is a greater probability of upside follow through than when the pull occurs amongst niggling oomph. Averaged together, nosotros run across no meaningful tendencies.
Now let’s purchase SPY when it closes below its lower Bollinger Band together with agree for 5 trading days. Now nosotros direct keep 43 trades: 28 winners together with xv losers for an average hit of +.98% together with a profits element of 3.14. That’s a meaningful bullish tendency. It suggests anti-momentum next weakness. When cost has dropped significantly, we’ve tended to bounce.
The trader who bought pull together with sold weakness during the terminal 3 years lost coin on average. It has been a trending market, simply non a momentum one. Executing based on momentum has turned a ordinarily winning style strategy into a losing one. Think most traders who merchandise amongst a “fear of missing out”, together with yous tin plow over the axe appreciate why that emotional designing is thus costly!
OK, thus let’s purchase SPY when its RSI is higher upwards seventy together with agree for 5 days. Now nosotros direct keep 122 trades over a 3 twelvemonth period: threescore wins, 62 losses, for an average hit of +.02% together with a profits element of 1.08. Meh. If nosotros purchase SPY when its RSI has been below 30, nosotros direct keep 24 trades: xviii up, vi downward for an average hit of +1.79% together with a profits element of 7.08%.
It’s interesting that traders often emphasize trading amongst the style simply non chasing trades. That’s an implicit realization that a directional bias doesn’t direct keep to live on a momentum bias. Many trends are traded best when they hold off every bit though they’re ending.
Further Reading: Price Momentum together with Cycles