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Trading – Trend following or top/bottom picker, which road should a trader take in the market?

Wed 26 Dec 2018 

In trading listed instruments like stocks, traders can usually choose either to be a picker or a follower. Stock market pickers are those traders that try to pick a bottom or top in the stocks that they trade in.

These traders believe that they have the tools whether they come from fundamental, quantitative or technical analysis that will predict the next market turn and help them get in before it really makes its move and get out just before it heads back in the other direction.

In the stock market, these types of trades are known as ‘bottom-pickers’ and ‘top-pickers’ or are alternatively known as counter-trend trades. The main disadvantage of this type of trade is that strong trends could persist in the prevailing direction and you could be wrong countless times before picking the real tops or bottoms.

Conversely, stock market “followers” use a somewhat more conservative approach. They follow the trend and rather than trying to catch the entire move, from top to bottom, their brand of analysis is geared to giving them confirmation that the market is indeed trending in one direction or another.

These groups are thus known as trend-followers.

One disadvantage of this group’s strategy is that they could be getting in by the time the market has already moved substantially and is ripe for a correction in the opposite direction.

In this way, they would also be caught near the top and bottom of the trend unless they try to get in early in the trend.

Which type of trading should you indulge in?

The answer likely lies in your own risk appetitie towards trading and your own risk and money management approach.

Typically, conservative traders should be a trend follower rather than a top or bottom picker simply because the odds of success are typically higher for the first type in the long run.

No stock market moves steadily down or steadily up. Instead, each movement in the primary direction is followed by a reaction, which can, in turn, be followed by another trust.

Each trust, measured from bottom to top or top to bottom, is known as “swing” or “move”. Each reaction or rally retraces part of the move and, therefore, is known as a “retracement”.

When the reaction is greater than the move, one must consider that the trend has changed, at least, for the near term. Retracement theory sets predetermined target levels for these moves and lends itself readily to computer applications such as an algorithm or system-based trade.

The general consensus in the stock market is that a normal retracement recaptures between one-third and two-thirds of the previous move while a 50% retracement is also very likely.

Students of Elliot Wave Theory in the stock market consider the Fibonacci retracement levels of 0.382 and 0.618 to be the most critical.

However, many aggressive traders also do well trying to pick “top” and “bottom”. By this, we mean trying to pick near the top and bottom rather than picking the exact top or bottom.

There are various ways to do the latter that calculates in advance the likely top or bottom target of a stock that a trader could act on. These would be good signposts that a trader could act on, for example in conjunction with other type of colloborating analysis, such as in taking profits or lessening his exposure gradually.

A study of big data analytics in the stock market would enable an elite trader to just take the best trend-following stocks or “top” and “bottom” stocks to trade in the market at any point in time, thus maximising the risk-reward ratio of each trade as well as the capital opportunities of your funds.

Without such big data analytics, a trader is likely to jump from stock to stock at the wrong opportunity and timing and trade half-blind oblivious to the overall sector or broad market prevailing trend. It’s like trying to swim up-river against the stream of water gushing down.

Whichever road a trader takes, he must also adhere to strict money management methods. Common traders suffer from many fatal errors such as overtrading, listening to others and not their own research and not developing a trading system with objective enter and exit levels.

Another fatal error most traders make is that they tend to put all their eggs in one basket in the stock market. In actual fact, to be a successful trader, one has to be diversified and maintain small positions in different stocks or markets at all times.

For example, you must be willing to go short any market that is trending down and buy any market that is trending up, and not hesitating to reverse your positions when the market reverses. You will need a diversified portfolio of stocks and this is not hard to construct when you have the entire market breadth and depth analysis such as in big data algorithm analysis of the entire market.

Trading in the stock market works because it is a study of human emotions and human emotions like greed and fear are unchanged over time like nature itself. To trade against emotion, the world of elite trading is now dominated by the use of algorithms in large markets by institutional funds.

In the current age of trading, where flow of data is instantaneous and the ease and availability of many global stock trading platforms, a retail trader could also trade global stocks or markets like an institutional fund instead of just relying on the home market alone.

The use of big data analytics and algorithm today has allowed elite traders and institutional funds to find the best performing stocks and markets around the world, a feat which would have been impossible to ponder in the past due to lack of access, tools and the cost involved.

To ride the new trend and keep your trading edge to win especially in volatile markets, you need to beat the elite traders and the market without feeling overwhelmed or overworked and use the latest trading tools and cutting-edge research.

Thankfully, all these are actually available today at a fraction of the cost and time that many traders are still unaware of.

Join and network with us at mPower Algorithm and mPower Trading and learn more about financial technologies in trading and the world of big data analytics and algorithm trading.