Trend Trading

1. Trend Trading: Riding the Elephant, Not Timing the Market

Trend trading is not about timing the market. It is about doing at least as well as the general market, and outperforming it.

Focus on participation. Trend trading isn't about predicting market tops or bottoms, but about identifying and capitalizing on existing trends. The goal is to "ride the rising tide" and outperform the market by aligning with its overall direction. As a small investor, you have advantages over large fund managers, including the ability to be nimble and react quickly to changing market conditions.

Small investor advantages. Unlike fund managers who must deploy large sums of capital, individual traders can be selective and focus on specific opportunities. This allows for greater flexibility and the ability to enter and exit positions more efficiently. The book emphasizes that small investors can use these advantages effectively.

Easy-to-apply methods. The book examines easy-to-apply trend trading methods to find these opportunities and to capture these types of profits. You can do this, and this book shows you how.

2. Embrace Probability, Not Prediction

The study of the market becomes a study of human nature and crowd behaviour.

Understanding crowd behavior. Instead of trying to predict the market, focus on understanding how people behave within it. Market activity reflects the collective emotions and decisions of buyers and sellers. By studying price charts, you can gain insights into crowd behavior and identify statistical relationships.

Probability over guesswork. Successful traders recognize that the outcome of any trade is not a 50/50 proposition. They use technical and charting indicators to identify where the balance of probability lies. This is not guesswork. It makes the best possible use of technical and charting indicators to identify where the balance of probability lies.

Trend continuation. Prices are most likely to continue in the same direction until met by an opposing force. A rising trend increases the probability of uptrend continuation. This plain, clear thinking stands diametrically opposed to mainstream and common thinking about market and price behaviour. In a trend there is not a 50/50 chance of price moving up or down. There is a 75% probability of the existing trend continuing.

3. Trading is a Business, Not a Gamble

Protecting your capital, growing your capital and finding the best return are the core tasks for the trader and investor.

Treat trading as a business. Shift from earning money to making money earn money for you. A successful trader develops a different view of the world of money, and the relationship between capital and income. This involves developing a systematic approach to managing capital and risk.

Capital preservation. The primary goal is to protect your capital. This involves using stop-loss orders and other risk management techniques to limit potential losses. The second goal is to grow your capital. This involves identifying profitable trading opportunities and maximizing returns.

Return on capital. Focus on the best return on your capital rather than the size of the dollar return. This means prioritizing trades with a high probability of success and managing risk effectively. The latter group focus on the most effective use of capital. They are not after a big hit — the gambler’s approach. They look for the best return on their capital rather than focus on the size of the dollar return.

4. Visual Analysis: The Child's Eye View

Sift through any collection of stock charts and some immediately stand out as clear and obvious trading opportunities.

Simplicity in charting. Some charts immediately stand out as clear trading opportunities. Avoid overcomplicating analysis with too many indicators. Simple tools can provide access to good profits in the market.

Eyeball test. Apply a visual test to identify stocks in a clear uptrend. This is not a complicated task and perhaps this is why so many new investors ignore it. Their preference seems to lie with what can only be described as ugly charts when prices fall dramatically from the top left of the chart to the bottom right.

Avoid "ugly" charts. Steer clear of charts showing dramatic price declines. These may seem like investment bargains, but they often lead to financial disaster. Their preference seems to lie with what can only be described as ugly charts when prices fall dramatically from the top left of the chart to the bottom right. These are investment bargains and they come with an invitation to financial disaster.

5. Trend Lines: Management Tools, Not Crystal Balls

These are probability tools directly related to the management of the trade.

Trend lines as trade management. Use trend lines as probability tools directly related to the management of the trade. Many traders use trend lines to define price action, often with a sneaking suspicion that they might be able to predict the future.

Beyond prediction. Move beyond classic applications of trend lines to examine the relationship between the trend line and better trade management. This turns the trend line into a powerful management tool.

Trend line triggers. The trend line becomes a trigger for action. Many traders use trend lines to define price action, often with a sneaking suspicion that they might be able to predict the future. This part considers these classic applications and then moves beyond them to examine the relationship between the trend line and better trade management. This turns the trend line into a powerful management tool.

6. GMMA: Decoding Crowd Behavior

The GMMA was introduced in Trading Tactics in 1997. Since then the indicator has evolved into more advanced and sophisticated applications.

Understanding trend character. Use the Guppy Multiple Moving Average (GMMA) to assess the character of a trend. The GMMA helps understand trend behavior and indicate the type of trading opportunity.

Trader and investor activity. The GMMA tracks the inferred activity of traders and investors. This provides insights into the strength and sustainability of a trend. The GMMA was introduced in Trading Tactics in 1997. Since then the indicator has evolved into more advanced and sophisticated applications. For many traders it has become the core way of understanding trend behaviour and indicating the type of trading opportunity.

GMMA as a filter. Before adding a stock to your portfolio, use the GMMA to define the trend and your entry point. This is examined in Part V. Our preferred tool is the count back line. This was introduced in Share Trading in 1996 and this technique has also evolved with more sophisticated applications. It is used as a stop loss to protect trading capital when a trade is first opened. We show how this is applied to mid-trend entries. We also show how the count back line is combined with the GMMA as a protect profit tool as the trend develops. This is a powerful trend trading combination.

7. Count Back Lines: Precise Entry and Exit

Our preferred tool is the count back line.

Defining entry and exit. Use the count back line to precisely define the trend and your entry point. This tool also helps commence the calculations necessary to manage risk.

Stop-loss and profit protection. The count back line is used as a stop loss to protect trading capital when a trade is first opened. It can also be combined with the GMMA as a protect profit tool as the trend develops.

Versatile tool. The count back line has evolved with more sophisticated applications. This was introduced in Share Trading in 1996 and this technique has also evolved with more sophisticated applications. It is used as a stop loss to protect trading capital when a trade is first opened. We show how this is applied to mid-trend entries. We also show how the count back line is combined with the GMMA as a protect profit tool as the trend develops. This is a powerful trend trading combination.

8. Risk Management: The Cornerstone of Survival

Risk is the cornerstone of the market, and yet so many people accept the assertion that high reward equals high risk.

Managing risk, not reward. Investment and trade management is about the management of risk. The idea that once a trade is selected the reward in the trade is about the same as the risk in the trade is shown in the first part of Figure 4. It comes from the assumption that the probability of rising prices is the same as the probability of falling prices. It further assumes the range of this rise or fall is evenly balanced. We could spend a lot of time showing why this is not correct, but we do not need to.

Stop-loss orders. Use stop-loss orders to limit potential losses. This effectively caps the risk at a defined percentage of total trading capital. Our own action in the market using stop loss orders limits the risk by capping the level of loss.

Small losses, moderate gains. Successful trades do not need to be large winners to grow portfolio returns. The key to success is the way losses are kept small. Those who fail to understand this also often have a lot of difficulty with the concept that a 60% loss in an individual trade is acceptable if the dollar value of the loss is less than 2% of total portfolio capital. A more detailed discussion of the implementation of these concepts is included in Part VI.

9. Darvas Boxes: Boxing the Trend

The approach developed by Nicholas Darvas represents an entirely different way of understanding trend behaviour.

A different perspective. The approach developed by Nicholas Darvas represents an entirely different way of understanding trend behavior. Originally developed and successfully applied to markets in the mid-1960s this approach was overwhelmed by the appeal of complex computer-driven analysis of the market and by increasing market volatility.

Buy high, sell higher. Retain the logic of Darvas's understanding of trend behavior and update the technique for application in modern, volatile markets. We retain the logic of his understanding of trend behaviour and update the technique for application in modern, volatile markets.

Construction rules. The Darvas approach uses specific construction rules to define the top and bottom of the box. These rules are based on price action and volatility. We examine the classic Darvas application. We retain the logic of his understanding of trend behaviour and update the technique for application in modern, volatile markets.

10. Modern Darvas: Adapting to Volatility

We retain the logic of his understanding of trend behaviour and update the technique for application in modern, volatile markets.

Ghost boxes. Use "ghost boxes" to manage risk in volatile markets. This involves projecting the height of the last valid Darvas Box to set a trailing stop loss.

Nervous volatility. Understand how to handle failure in Darvas trading. This includes recognizing when the trend is no longer valid and taking appropriate action.

Darvas dividends. The Darvas approach does not adjust for dividends. This is because the market is expected to factor in the dividend payment.

11. No Secrets: Skill Trumps Information

Profits come from the way we use information and we can all be successful.

Level playing field. Trading success rests on what you do with information which is also freely available to all your competitors. Success may appear difficult or impossible when everybody knows exactly the same information, but this is just a mirage.

Personality and trading. Each of us has a different personality. When deciding to buy or sell, we include a veritable container-load of extraneous baggage. Even if we apply a mechanical trading system, such as those black boxes advertised in glossy hard-sell brochures, we are no better off because ultimately we send the buy or sell order.

Trading skill. Profits come from the way we use information and we can all be successful. This is the true secret of performance plus in trend trading.

Last updated: February 28, 2025