Possibly the most important aspect of technical trading is the concept of a trend. A trend is most simply a series of prices increase (or decrease) from start to finish. At the end of the trend is a turning point at which the price starts a new trend.
There are many problems with this overly simplistic view.
The appearance of a trend depends on scale. If you look at AMD over 5-years, you can see a 3-humped ‘M’ shape with some relatively insignificant noise along each leg.
If we zoom into the second up-trend on the middle hump, we see something different. Certainly, the price is moving up, but there is a distinct zig-zag to the price and no one date we can really call the turning point, though February 27-28, 2011 appears to be the maximum of this graph. Couldn’t we make more money by breaking this single trend up into smaller trends?
The answer is not that simple because it depends on how much money you have to spend.
Determining the Trend
Normally, a trend is determined by applying a moving average to the closing price. If the price is above the moving average, the trend is up. If the price is below the moving average, the trend is down. Unfortunately, this method is limiting, especially around large price movements.
Here is a simple method for identifying a trend:
p = current_index - 1;
while( price[ p ] < price[ p+1 ] ) p—;
The trend is the maximum current_index that traces back to the same p.
Using this method, we quickly notice that there are small jitters in what we as humans would consider a trend. Often these jitters are a single price not fitting the trend.
p = current_index - 2;
while( price[ p ] < price[ p+1 ] OR prices[ p ] < prices[ p+2 ] ) p—;
This methods works better, but it can be generalized to take a time period and to detect downward trends as well.
Why Money Matters
I have highlighted the detected trends that would make money given an amount that can be spent per transaction. I have used the last 5-years of AMD with an algorithm that ignores up to 10-day jitters as the example.
At $50 per transaction
There are only three possible trends, all of them up-trends, that allow a $50 transaction to make money. This is assuming a $10 transaction fee for both buying and selling. The trend had to make at least 40% of the transaction cost just to break even!
At $100 available per transaction
There are 14 possible trends that will make money now, 5 down-trends and 9 up-trends (some of the green lines are very close together, but they are separate). Notice that the middle hump we looked at before has no trends that would be profitable.
At $200 available per transaction
More of the chart is colored now. Many of the obvious up-trends appear properly highlighted now, but there are still areas of the chart that are uncolored. I need to do more work in assessing the risk of a transaction at any point on the graph. We can consider these dangerous areas.
At $1000 per transaction the graph starts to look different
Notice the green interspersed along the down-trends and the red interspersed along the up-trends. This means that the tiny jitters in price have become meaningful and potentially profitable. The zig-zag non-movement of the price between Jan 2013 and May 2013 has potential for no less than 12 profitable transactions. Notice there were only 14 possible profitable transactions in the entire 5-year run of AMD if only $100 were available per transaction.
Why is it “per transaction”?
It comes down to risk. How much of your total money are you willing to lose on any given transaction? Typically, this is 10%. So, to have $1000 available per transaction, you would need to have $10000 in your account and you could have up to 10-$1000 transactions active at any one time.
If you only have $2000 in your trading account, 10% risk only allows $200 per transaction.
The difference between rich and poor is opportunity. When they say “you need money to make money” it’s entirely and bitterly true. Using the stock market as a retirement fund because it works for the rich is a cruel joke. Unless you have enough to retire on, you can’t seriously participate in the stock market as an entity and make your own decisions. Instead, you need to rely on other peoples’ decisions where they not only risk your retirement but the retirements of many others on a single transaction.
Unless you can reasonably make a profit off a transaction, the only reason to buy stock in a company is self-satisfaction. Buying less than 100 shares just isn’t worth it. The examples above use a stock valued between $2 and $10 over the last 5-years. Consider what it would take to make a reasonable go at a stock priced around $30.
It’s easy to panic at numbers. The graph of Microsoft looks about as colored in as the graph of AMD given $1000 per transaction. Higher valued stocks do have larger price movements than lower valued stocks so individual shares are effectively worth more on a higher valued stocks.
MSFT at $1000 per transaction
What’s really important to take from all this is that trends are imaginary. Trends may be real in the sense that the price does move up or down for extended periods of time, but that movement is still random. Detection mechanisms need to be fudged to properly find a trend and even then, the trend can only be found after it has passed. Detecting a trend that is happening and taking advantage of it is possible. People do it all the time.