The Trend is Your Friend

There are two widely used analysis frameworks when getting to a decision to buy, sell or hold a publicly traded investment.

The two frameworks are Fundamental and Technical. Fundamental analysis tends to focus on anything related to the companies balance sheet and income statement. A common fundamental value people often site is the P/E Ratio. The formula is the price of the security divided by the earnings per share. Typically speaking, a lower P/E ratio relative to a higher P/E ratio says the company's stock price is undervalued.

Technical analysis focuses on the movement of the price – the supply and demand of the stock. A pure technician would only look at price action and not so much care about the P/E ratio. The technician focuses on the trend, or lack thereof, of the stock. In order for someone to implement and study technical analysis, they must believe that prices move in trends. If one doesn't believe this, they are going to have a hard time identifying price action.

The Trend is Your Friend is a technical concept and works under the assumption that price action will continue in the direction it is going until enough pressure from the other side reverses or at least stalls the trend. Prices tend to oscillate from trending up, sideways and down. What can complicate this is that there are different time frames. For example, the daily trend can be up while the weekly trend is down. This is why it is important to decide which time frames you are going to participate in ahead of time or before you buy the security.

The trick is to be able to identify the trend in your stated time frame and get in before it ends. This is why we track the different markets and categorize them into one of five categories…Stage One – trending sideways after a decline in price, Stage Two – trending up, Stage Three – trending sideways after an advance in price, Stage Four – trending down in price, and Unclear – it looks like a lot of noise and we can't clearly see the opportunity.

We used to not have an 'Unclear' section and try to fit every security into one of the four. After letting go of having to define the unclear securities and adding them to a list for later review, it has freed up time, mental space and helped to clear the vision of the most probable price action.

When looking at a security, we want to identify the trend and then only trade in the direction of that trend…nothing else. There is one caveat to trading with the trend…The trend is your friend is really only half of the statement since there is no certainty in the stock market.

The entire concept to understand and operate from is "The trend is your friend until it ends." Trends do end. Our solution is stop losses. So here is what we do in short…identify the trend, look for entry criteria and a single event trigger to take action, define the risk, use a stop loss in case our bias is wrong.