In an effort to control outcomes, part-time traders spend a lot of time and money trying to find reliable means of predicting future price movement from previous price action. Worse, the unpredictable nature of the markets and the lack of control people feel when contemplating it, prevents a large group of people from ever trading their own money.
The random nature of the market and the pressure caused by trying to find the perfect entry generally sorts people into four distinct categories.
What this means for the stock market is that stock prices often move in directional trends. One mathematical equation, known as the Arcsine Law, states that stock prices will tend to follow their trend higher or lower more frequently than simply drifting sideways. Another way of understanding this concept is that stocks will continue following their trend…until that trend ends.
In practical terms, traders can use the incredible charting packages available today to map historical price action for any stock and for any desired time frame. As charts are studied, a trader can see that random markets generate directional trends. This pattern is true for any time frame…prices always move in patterns that can be described as either up, down, or sideways.
Random data will always pick a trend and for stocks, that trend has historically been bullish despite the price fluctuations caused by the day to day decisions of millions of traders.
Upward trends are categorized by a series of higher highs and higher lows. Downward trends are generally described by a series of lower highs and lower lows.
Sideways channeling is a lot more messy in that anything that isn’t clearly up or down trending can be lumped into this category. These stocks might potentially experience volatile price moves in either direction followed by a quick reversal to the mean. Some traders consider this sideways movement the building up of energy which is unleashed as the stock breaks through into a new directional trend. The longer the sideways channel, the bigger the expected move on a breakout.
The very nature of price action in a sideways channel means that identifying a breakout can be challenging without some sort of confirmation. Cautious investors confirm the breakout is real and not just a fake out. A breakout requires some sort of change in investor perception about the company or macro market sentiment, which is both unpredictable and hard to point point in real time.
People who identify as any of the five Natural Trading Styles may decide to employ strategies to exploit market movement in directional as well as sideways trending moves. To profitably trade these trends, a trader must have a complete trading process of expectations, rules, and a feedback loop for constant iteration and improvement.
That said, those who trade sideways trending channels generally expect short hold times as prices quickly cross back and forth across the mean. These traders expect many small gains compared to a few larger losses.
Trends can be found on any equity and for any time frame. The challenge traders have is that sideways trending channels become trends and trends eventually change. Successful traders learn to adapt their market approach to the new direction as they appear or find new stocks to trade.
The most dangerous point for any trader are the inflection points where trends change. These points can be sudden, unpredictable, and hard to accept. This is one of the barriers those who struggle to trade real money face.
What we hope you learn through this process is that it’s okay to lose trades. Losses are an expected part of any trading system. In fact, base win rates with a higher percentage of losing trades actually make more money.
The most important thing is to have confidence which is best built on a foundation of statistically relevant expectations and trading rules.