The market has 4 basic phases and no trading system is suited to all of them. Some systems are suited to Phases 1 and 3, when the market is ranging, while others are designed to trade the trends in Phases 2 and 4. Trend-trading systems are more popular as they require less time and normally generate larger returns.
Active or Reactive?
Many investors follow active strategies but end up being reactive, rotating in and out of stocks at the wrong time.
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The object of trend-trading is to go long at the transition from Phase 1 to Phase 2 and to exit before Phase 4. Some models also short the market during Phase 4, but this should be left to experienced traders .
Successful systems are built around the following principles:
- Selecting securities.
- Market direction.
- Trend direction.
Using the same indicator, check the Trend Direction of each security.
- Entry signals.
- Stop losses.
(a) Set Stop Loss Orders as soon as your trade is confirmed.
(b) Do not exceed the Maximum Acceptable Loss.
(c) Be technically consistent when Setting Stop Levels.
(d) Adjust Stop Levels over time to protect your profits.
- Exit signals.
Take Exit Signals from a suitable trend indicator.
A Word Of Caution
These are typical steps that a trader will follow in deciding what stocks to buy, when to buy them and when to sell. It is not a magic formula, but consistent use should enhance your investment performance.
Trading methods can be compared to a carpenter's tools: Skilled use can produce outstanding results but unskilled use may lead to injury. Learn to use your trading tools properly before committing any capital. Study the behavior of the indicators over several years, learn their strengths and weaknesses and how they interact with each other and with the market. Start with a small amount of capital and only increase this when you are confident that you have a winning strategy.