This works better than any market prediction technique

Any financial product comes with a disclaimer telling us that ‘past performance is not an indicator of future success’ – usually just after they’ve told us about how great the past has been, implying (with a wink) that the future will be just as rosy.

When we enter the market, we’re doing so in the hope that we’ve judged future market direction correctly. However sanguine we may act, we’ve got our fingers crossed that we’ve picked the winner.

So, when traders say ‘Ah ha, you can’t predict the markets’ … I suspect we don’t really believe it, because we spend much of our energies doing something that looks very much like trying to predict the markets!

Usually, the market prediction tool of choice is the technical indicator (in fact, a whole toolbox full of them). If we add enough technical indicators to our charts, with the right settings, we can predict what’ll happen next. Right?

I’m a technical trader myself, and it’s a technique I’m all too familiar with.

If you’ve read technical analysis, listened to market pundits, tried to predict market direction … and ultimately been left disappointed … I suspect you may be hoping for a better way of doing things.

And here it is …

First off, let’s accept that even a leading indicator can only give us information about what has already happened. Any projections we make from that into the future are based on how we chose to interpret that information.

So, rather than trying to forecast what the markets going to do, we’re only going to be interested in what the market is doing RIGHT NOW.

Immediately, you can throw out all that stress about which way the markets are going to move – all you want to know is what’s happening in this instant. Is the market going up? Is it moving down? Or is it not doing either of these things clearly?

No reading of tealeaves or complex chart data – the most basic trend-following indicator is able to give us this kind of information.

But there’s a clever bit …

Statistical models may not be able to see into the future, but that doesn’t mean we can’t use stats to give us the edge. And trade management is exactly where this kind of smart modeling and predicting comes into its own.

Risk management throughout the life of our trades is where money is made. All trading methods will go through good and bad runs – but effective management allows us to maximize the wins, while minimizing the drawdowns. This is the only way to keep on building our wealth long-term.

Putting it together

This style of trading is incredibly simple, but potentially very powerful. It has just two key elements:

1 • trend following
PLUS
2 • active risk management

It represents a move away from the importance of your trade entry, with greater focus on risk management and exits.

I’ll be digging into the details of this over the coming weeks, and look forward to hearing your thoughts.

 

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