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Long Term Vs Short Term Investing:
What is Best ?

If You Ever Wondered:

How Long Should I hold Stocks?

Should I go for long term investments or make it short term?

Should I hold it forever, like Warren Buffet?

These are some one of the most common questions that new investors ask.  And, tricky ones to answer!

This Guide will help you to find answers to these questions.

Here is what you will find inside this guide:

 

 

FACTS

Equities = Stocks Are The MOST DIFFICULT Asset Class To Invest!

The majority of  investors are attracted to stocks because it seems like the easiest asset class.

There are the success stories, the books, Warren Buffet , Value Investing aficionados and etc.

We all know, more or less, what a company is and what their shares represent.

It’s easier to relate to than commodity prices, bond yields or foreign currencies.

Most people invest or trade stocks from companies that they believe they understand.

Let's See: If you go to Starbucks, Dunkin Donuts or Krispy Kreme for your morning coffee and donuts, you have a connection with one or all of these firms. On the top of it, you grab your hands  (and read) all you can find about it, therefore it is fair to say that you have a very good understand how their business works.

The sames goes for you new neat iPhone 6 and iPad; You are an Apple Fan. Most likely, you read a lot about Apple, its products, interesting facts. competitors and get know a lot about the firm. This builds a strong motivation to buy Apple stocks.

All sounds nice and easy but in fact, this is an illusion.

Your experience with Starbucks coffee, Krispy Kreme or Apple iPhones is not really helpful for predicting future stock prices.

It only seems like it, after the fact.

This is an illusion that it’s very easy to be fooled by.

When you look at the names of publicly traded companies and relate  your own experiences with them, it’s easy to get influenced by this.

More so when the greatest investor of all time - Warren Buffett - tells you to do so, right?!

If you like their products, you feel that the share price should rightfully move up. If you think that they’re outdated or have a flawed product, you feel that the price should be falling soon.

Most likely, these ideas are not helpful in trading the stock in question.

In financial circles, this is called INFORMATION BIAS!

It’s very easy to look back at a larger price move and think that it was so obvious that this should have happened.

Perhaps you look at the dramatic rise in Apple or Microsoft stock prices historically, and hasty conclude that it was easy and obvious to say that they would have dominated not only the software business but the whole stock market.

After all, these are the makers of some of the most wonderful tools we use today.

This was, in retrospect, a NO BRAINER!. Crystal Clear, wasn't it?

And yet, it was very far from clear at the time.

Let's look at Microsoft for a second.

Sure, in the generally prevailing insanity of the Dot-com era, everyone threw money at any tech stock like there was no tomorrow.

But the people buying Microsoft were generally the same that bought Worldcom, Global Crossing, AOL and many other companies that dominated Headlines by filling for Bankruptcy and often enough by Defrauding investors in spectacular fashion.

It just looks obvious looking back ins't it?

Hindsight 20/20!

Quite often companies with great products and seemingly great strategies perform poorly in the stock market.

Equally often it’s the other way around, with insane sounding concepts skyrocketing.

Again, wait until after the stock has moved enough to make headlines, and now it seems so obvious to everyone why it all happened.
There are certainly people who are very good at fundamental analysis of companies and industries.

They’re experts in figuring out what will happen in the long run and usually go into extreme details in their analyses.

This is a very difficult game and it goes a lot deeper than liking or not liking products.

These analysts are often specialized on just one sector or even a few stocks. They follow every detail and analyze every row of their income and balance sheets.

It’s a perfectly valid approach to the financial markets, given sufficiently hard work of course, but it’s a full time profession in itself and not easy to pull of.

A very similar illusion is the belief that you have an advantage in trading the stock of the company you work for.

It would seem to most people as if their inside knowledge of the company helps them understand the market and achieve an edge in trading. Unless you’re part of the top echelon of your firm, this is non-sense!.

Even if you’re top management or a non-executive director, it’s doubtful that you will have any advantage more than at special situations such as just before an important announcement.

Those special situations are of course illegal to trade on, generally speaking.

In fact, buying the stock of the company you work for is irrational.

First, you don’t have any sort of advantage in trading it compared to any other random stock out there.

Just stop and think about it for a second:

If it worked that way, the employees of any publicly traded company would make more money on trading these stocks than they would on their salaries.

It’s just an illusion.

But it get's worst!

By investing in the company you work for,  you’d be compounding your existing risk in a single company.

Yes, you’ve already got a risk exposure against the company you work for. Just think about it.

If they don't perform well, you might get fired. but If they do well, you might get a raise and a promotion.

By purchasing the stock, you’re just increasing your risk against the same entity, without any rational reason for doing so.

The Stock Market gives people the illusion that there are endless possibilities and you can diversify risks away always being safe.

Well, the problem is that when things go wrong, they all behave the same. When Crisis happen, Regardless how  well you diversify, you will be in for a very rough ride.

The so called correlation in stocks works in a very funny way. 

In Bull Markets, most Stocks advance, with the GOOD STOCKS OUTPERFORMING.

In Bear Markets, They all get hit! 

And they do so, EQUALLY! 

Meaning, they FALL AS HARD AS THEY CAN AS FAST AS THEY CAN... a la Financial Crisis 2007/2008!

So, that is when a WELL DIVERSIFIED PORTFOLIO THEORY go out of the window!

So, before deciding Long Term or Short Term, Educate Yourself!

That is the best  Investment Strategy - either Short and Long Term!

Personality, Expectations & Funds

The short answer to the question is:

There’s no universal rule that applies to all stocks when it comes to holding periods. many variables will determine how long you wish to hold a stock.

Whether you hold stocks for the long term or the short term is a personal decision that only you can make, according to your needs, expectations or perhaps after consultation with a competent advisor.

Similar to most topics related to investments, the answer is not always straight forward, but there are several factors that will help you make that decision.

However,  before diving into the subject, we should ask ourselves a different question and that question is:

Are you asking the right question?

well, I don't think so.

In fact, before getting to the advisor, one should do a "PERSONAL AUDIT" and deal with the variables that will enable him/her, to ask an advisor the right questions.

FIRST: REALITY CHECK!

Defining investment horizon, risk appetite and expectations are integral parts of Investing or Trading.

For Investment professionals the term used is Investment Horizon while in trading people refer more commonly to it as TIMEFRAME.

However, before delving into technicalities, let's deal with Realities!

Which Realities?

Capitalization, Expectations, and Personality!

These important questions must be answered before defining investment horizons, strategies & portfolio selection . These variables will help determine very early the type of investment or trade is right for you.

The decisions have a lot to do with the availability of funds, HOPES, and Personality. They are intertwined and play a significant role in this process.

So before starting any activity, one should answer a couple of questions. Here is a short list"

INVESTOR PROFILE CHECKLIST!

  • How much money do I have to invest or trade?

In fact a far more correct and honest question to ask is: How much money I am willing to risk and therefore LOSE in order to try to make some money in stocks, ETF's, Forex or Managed Futures

  • Will You Need The Money In The Near Future?
  • Are you investing for Retirement or Do you have a term in mind i.e. 5 years?
  • What About Taxes?
  • Do I have a good understanding of  Risks associated with Investments/Trade activities ?
  • What are my Expectations? (HINT: Yearly Based Percentage Return
  • Are they realistic?
  • Do I have the Personality to pursue this endeavor? (Hint: can you deal with losses?)

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What is the difference between Long & Short Term Investing?

At various times, people may feel frustrated by the performance of their stock or fund investments.

For example, they expect growth, and they don’t get it — or they think the value of their investment won’t fluctuate much, but it does.

As frustrating as it may sound, that is absolutely normal and yet people are upset.

Some of this frustration might be alleviated if investors were more familiar with the nature of their investment vehicles. But, in many cases they underestimate reality.

Specifically, it’s important to keep in mind the difference between long-term and short-term investments.

What defines long-term and short-term investments?

In general, Long-term investments are those vehicles that you intend to hold for more than one year — in fact, you generally intend to hold them for several years.

On the other hand, you usually hold short-term investments for one year or less. You can find several key distinctions between short-term and long-term vehicles. Here are a few to consider:

They carry different expectations.

When you purchase an investment that you intend to keep for many years, you may be expecting the investment to increase in value so that you can eventually sell it for a profit. In addition, you may be looking for the investment to provide income.

On the other hand, When you purchase a short-term vehicle, you are generally not expecting much in the way of a return or an increase in value.

Typically, you purchase short-term investments for the relatively greater degree of principal protection they are designed to provide.

They meet different needs at different times of life.

You will have different investment needs at different times of your life.

When you’re young, and just starting out in your career, you may require a mix of long- and short-term investments. You might need the short-term ones to help pay for a down payment on a home, while the long-term ones could be used to help build resources for your retirement.

But later in life, when you’re either closing in on retirement, or you’re already retired, you may have much less need for long-term vehicles, with a corresponding increase in your need for short-term investments.

They can satisfy different goals. If you purchase investments that you intend to hold for the long term, you probably have a long-term goal in mind — such as building resources to help pay for a comfortable retirement or leaving a legacy.

On the other hand, a short-term investment would be more appropriate if you know that you will need a certain amount of money at a certain time — perhaps to purchase a car or to fund a vacation.

 

Investor Profile Stock Market

They carry different risks. All investments carry some type of risk.

One of the biggest risks associated with long-term investments is volatility, the fluctuations in the financial markets that can cause investments to lose value.

On the other hand, short-term investment vehicles may be subject to purchasing power risk — the risk that your investment’s return will not keep up with inflation. As an investor, you’ll probably need a mix of long-term and short-term vehicles.

By knowing the differences between these two categories, you should have a good idea of what to expect from your investments — and this knowledge can help you make those choices that are right for you.

Market Volatility

One of the main concerns for any type of investing is market volatility.

Volatility measures the degree to which prices change over time.

Another way to think of volatility is in terms of price swings.

The greater and more frequently an investment's price swings, the higher its volatility.

Investments with high volatility have a high degree of risk because their prices are unstable.

Market Volatility is a source of stress for most investors.

But if you take time to learn a bit more about it, volatility can be viewed in a more positive light.

Price changes show that markets are working as they react to new information and it is translated into stock prices.

Following a robust investment philosophy can help better withstand the shifts and guide behavior during periods of uncertainty.

That is why it is important to select an Investment philosophy that match one personality. An investment philosophy that matches our personal philosophy can help us deal with adversity in other areas of life.

Following a philosophy you trust will help you to stay disciplined. One of the most important aspects of investment is discipline.

By better understanding markets, having realistic expectations and feeling comfortable with uncertainty, one can achieve excellent results.

Discipline and confidence will allow you to relax in the knowledge that you are well positioned to participate in capital market returns over time.

What About Professionals?
Are They Long or Short Term Investors?

Professional Money Managers Investment Horizons

An interesting Report Published by Mercer Consulting, has shown that even Professional Money Managers struggle with determining how long they should hold stocks.

The aim of the research was not to prove that long-horizon investing is “good” and that short-horizon investing is “bad” (or visa versa), as we recognize that there is a valid role and function for all types of horizons and approaches to investment.

Rather, the aim was to examine the extent to which there is a mismatch between the time horizon over which investors think and say they invest and how they actually invest.

The result was very interesting and surprising.

What they discovered is that Short Term was far more prevalent than otherwise advertised.

It became clear that money managers shift stocks far more often than they advertise. Turnover rates far higher than expected.

Nearly two-thirds of strategies have turnover higher than expected, with some strategies recording more than 150% – 200% higher turnover than anticipated.

Of the 822 strategies for which we had both expected and actual turnover data, they found that 540 of them (or 65%) exceeded their expected turnover over the sample period.Of these products, the turnover was, on average, 26% higher than anticipated.

In some cases when managers exceeded their expected turnover level, the difference was very large, which could be of concern for institutional investors due not only to the impact on transaction costs, but also to the risk that the strategy is not being managed in line with its stated investment approach.

The main causes of this trend towards Short Term were:

MARKET VOLATILITY

CHANGE IN MACROECONOMIC CONDITIONS

CLIENTS FEARS

Interestingly, fund managers recognized the potential negative consequences of short-termism, even while claiming it is unavoidable. The key themes (from the fund managers’ perspective) were:

  • short-termism is part of how the market functions;
  • it places short-term pressure on companies;
  • it increases market volatility; it potentially demonstrates a lack of discipline in fund managers’ investment processes;
  • and it potentially creates a misalignment of interests between fund managers and their clients

The overall opinion is that what defined  longer Term investment in the past, has evolved to a much shorter time span today. Holding stocks for very long periods presents challenges, even for professionals.

Behavioral finance evidence suggests that investor psychology and speculative investment activity contribute to higher asset price volatility, creating a vicious cycle of asset price volatility and short-term horizons.

The Stock Horizon Strategy

I will offer an alternative here; I will call it the" Stock Horizon Strategy"

What do you mean?

What I mean is, you take the decision based on your capitalization and investment goal.

Again, both short term and long term investments have their pros and cons and the end result can be quite different. Short term is often unclear; hence I would say, considering the uncertainty involved in every day stock movements, long term is a pretty good bet.

If your goal or wish is to maximize your profitability with a short term strategy, then it is very important that you time the market right, which requires expertise and is quite challenging. Failing to time the market just right, could be disastrous.

On a day to day basis, it is very hard to predict where the market is heading. Trying to do the same for a longer term, i.e. over a decade, improves the odds.

Going by the historical data, since the 1930's, the stock market has never had a negative 10 year period, and since 1950, there has never been a negative 20 year period.

From a probabilistic perspective, It is fair to say that a long term approach improves the probability of success.

The longer you are invested in a stock or stock market aggregate, larger are the chances of your stock winning. Your ability to hold against adversity, will eventually help you to make profits.

Let's assume a scenario:

A recent report is recommending the purchase of Apple Stock or a currency, let's say, apple stock - AAPL or a currency, US Dollars.

If somebody tells you to buy AAPL or US dollar because it is likely to rise, make sure you understand whether the stock/ dollar is expected to rise over a few days or a few months.

That is the first step.

The next step is to determine if you should buy the stock/ dollar with the intention to hold it for several days, several weeks or several months. Once the decision is made, you can further explore the implementation of this strategy.

The Importance of Capitalization

I may sound very harsh in what I am about to say, but investors should think twice before investing if they LACK FUNDS. In Layman's terms Small Investment Account.

Capitalization is a key Factor in Investing, principally for Long Term Investors.

Undercapitalization added to lack of RISK understanding, are the main factors behind most Investment horror stories.

You can develop the required mindset and the skills to invest or trade. You develop the discipline to follow a particular strategy. It take time and efforts but it is possible.

In some cases, you be a LUCKY individual that possesses an innate ability to pick stocks develop skills and acquire the knowledge very fast.

However, if you lack capital, you have a problem.

For Instance, long-term investing or swing trading a volatile stock or futures product with a relatively small account is unrealistic. To withstand the volatility shifts, you need capital.

The Longer the Horizon, Higher The Risks!

The Race Towards Profits

When people decide to invest or trade, they do with one objective in mind:

TO MAKE MONEY!

TO GENERATE PROFITS!

TO WIN!

We all hope to make money when we start to trade or invest. That is the motivation and the main expectation. Money is the catalyst and there is Nothing wrong with that!

However, before getting ahead of yourself, try to consider the possibility that things may NOT GO AS EXPECTED!

Most investors simply think about REWARDS. Rewards are the motivator!

The large majority of people invests with FINANCIAL REWARDS In MIND. Very few Invest or trade simply for the thrill.

And, to make matters worse, THEY HATE TO LOSE!

 

Crucial Component: RISKS

Thinking about PROFITS, means simply thinking about REWARDS. Solely think about rewards, means ignoring RISKS!

The vast majority simply Neglect or Ignore RISKS. They talk about it but in reality they react differently.

Most Non-Professional investors understand the concept. But few, spend the necessary time to master this concept.

They have the concept somewhere back in their mind, but they don't take the time to study the implications of risks exposure. They often convince themselves that all will work just fine.

BE AWARE of Risks, but that comes far behind in their priority list. It is the motivator! The large majority of people invests or trades simply for the thrill.

Everybody wants to find a method, strategy or set up that works.

People search for systems that have proven successful historically. They look at the percentage returns or winning ratio. Few people search for the volatility, or drawdowns.

People spend countless hours looking for the a secret weapon to beat the Markets, but they don't spend a fraction of the time trying to learn the concept of Risk!

Understanding risks and the relationships between risk exposure and profitability are crucial towards investment success.

Long Term Investment Timing Techniques

Top Down Analysis

A top-down approach is often the most effective.

Please note that, when I say effective, it doesn't mean Perfect or certain. I

t is important to keep things into perspective.

One starts with the large time frame, move down to the medium time frame and consequently to the small time frame.

Once an investor or trader has defined the investment horizon, he can establish the appropriate framework.

Institutional money managers, Mutual funds and global macro hedge fund managers, tend to pursue this type of strategy. They select their holding based on Macro and Micro economic factors.

Economic Fundamentals, in general, have a response lag.  A "Lag" is a slow response. In this case here, it means that it usually takes time for the markets to digest the news and asset prices to adjust to these changes. In "general", there is a lag between data and market reaction.

There is no such thing as perfect timing. Nobody really knows how long it takes for changes to be accounted for.  As rule of thumb, these factors tend to take between 3 to 12 months to be absorbed. This is called Impact Lag.

The most important factor for investors it to determine the approach that best suit their needs. If you have decided to follow the long-term approach, long terms charts will best fit your needs and this type of investment strategy.

Combining the economic analysis with a technique such as the Dow Theory, can provide a straight forward framework.

Global and Macro Economic Sensitivity

The behavior of most Financial products  is affected by Global and macro-economic events & factors.

As new information comes in, market participants digest and react to new variables and adjust their exposure to markets. Adjustments reflect their views and beliefs on how markets will react to the new information.

Long-term time frame charts tend to illustrate this phenomenon. Large players control large capital flows. Their actions tend to impact market behavior. Therefore, a trader should monitor the major economic trends when following the general trend on this timeframe

Higher timeframe charts tend to capture and illustrate this phenomenon.

Frequencies such as weekly or monthly periodicity tend to display the shifts in overall opinion. They tend to have a significant impact on market direction.

Whether the primary economic concern is unemployment, economic growth, current account, political events or any other number of influences, these developments should be monitored to better understand the direction in price action.

Some events take place monthly, others quarterly and selected few annually. It is important to monitor occasionally to keep things into perspective.

The Law of markets dictates that funds will flow into asset classes that provide the best risk premium

 

What is the Right Time Frame?

There is no right or wrong in trading or investing. There are Silver NO Bullets in trading or investing.

It is impossible to find perfect solutions or one size fits all methods.

A combination of solid methods aligned together, such as risk management, capitalization, volatility adjustment and statistical methods help improve the probability of success.

In short, Sound Discipline and risk management!

What will define the most appropriate timeframe is a combination of factors. The most important factor in my opinion - above all else - is Capitalization. It is then followed by risk tolerance and expectations.

Putting these elements together, provides a well structured framework.

That is the disciplined way to define Investment or Trading Horizon.In layman's terms, it means simply how long you want to hold a trade.

It all boils down to how long you would accept to HOLD a position and exposed yourself to market Risks and uncertainties in order to seek Rewards, to make money.

Once that is defined, the frequencies can be selected.

Multiple Timeframe analysis.

The Magnifying Lens Method

The Multiple Timeframe methodology consists of analyzing a financial instrument across different time frequencies / timeframes.

This process is also called time compression.

There are no limitations regarding the amount of frequencies to be monitored or which specific time frame to be used. The general rule is to use 3 or 4 different time frames.

The objective of multiple timeframe analysis is to analyze markets from a broad perspective to a compact and very detailed one.

There isn't a perfect combination or method. It is a matter of personal preference as well as fine tuning the selection to one's investment horizon.

All we are trying to accomplish with this process is ,to simply look at the market through a magnifying glass or lens.

The primary advantage of using multiple time frames is that you can see a pattern develop sooner.

A trend that appears on a weekly chart could have been seen first on the daily chart. The same logic follows for other chart formations. Similarly, the application of patterns, such as support and resistance, is the same within each time frame.

When a support line appears at about the same level in hourly, daily, and weekly charts, it gains importance.

Charles Dow Trend Analysis

The Charles Dow Investment Theory

A little over one hundred years ago, Charles H. Dow wrote a series of editorials in The Wall Street Journal in which he laid out his views of how the stock market works; collectively these writings are referred to as “The Dow Theory.”

The work of Dow is as important today and forms an underlying premise of technical analysis.

Mr. Dow never had the opportunity to publish all his work.

He died before the complete his theory on market behavior.

However, some of his pillars have contributed to his theory and expanded on the principles that have formed the Dow Theory.

Foundation: Trend Analysis

One of the foundations of the Dow theory is the fact that markets discount everything. All past, current and future information is discounted into markets and prices are the expression of opinions.

A major premise of this theory is that Mr. Dow concentrate on the movements of Major Indexes in order to define the dominant trend or primary trend.

The next step in this process is to distinguish the overall direction of markets.

To gain broader understanding, Mr. Dow followed the process called Trend Analysis.

Trend Analysis consists of the identification of three types of price trends: the primary trend, the secondary or intermediate trend and finally the minor trends.

Let's see:

The primary movements were compared to oceanic tides. They are the main trend of the market whose duration can last from a few months to several years.

Primary trends cannot be manipulated, as the forces of supply and demand are too large for any one participant to successfully influence the collective reasoning of the crowd.

Secondary movements were referred to as waves and they are known as reactionary moves, trends that typically last from two weeks to three months. The secondary movements are often created by the activities of large participants - mutual fund, hedge fund, etc. -during the process of liquidation of all or a significant part of their holdings; once that supply (in an uptrend) is absorbed by the market, the buyers regain control and the stock continues higher in the direction of the primary trend.

Finally, minor (or short-term) trends were viewed as insignificant oscillations, called noise today, which lasted less than two weeks and were given little significance because they represent fluctuations in the secondary trend. The short-term oscillations in the market can be difficult to predict because they are often driven by emotions.Things have changed and markets evolved ever since. Technology and structural changes have allowed astute participants to take advantage of these rotations. Today skilled short-term speculators and traders thrive on this type of emotional short-term movement.

Dow Theory as Investment Timing Tool

According to the theory, Investors should select 3 different horizons (timeframes) in order to identify the primary, secondary and minor trends in place.

Long term charts such as monthly, weekly and daily will provide the best overview for Investors. It is a way to synchronize asset behavior with economic and industry-specific data for long-term investment horizons.

Following the principles of Charles Dow, There are two combinations that fit long term strategies:

  1. Monthly charts to define Primary Trends, Weekly for secondary trends and Daily for minor trends
  2. Weekly for Primary, Daily for secondary and 4 hours charts for minor trends.

Long term investors make decisions based upon  fundamentals but rely on technical data to refine entries, manage risks and adjust portfolios. They use charts to find areas of interest and place their trades.

Long term investors place orders in stages. They don't look for specific prices but for zones of interest.

The long term supply and demand areas from the past provide some opportunities. When these are not present, they use statistics to calculate what are called future projections or measure moves.

Typically, using three different periods provides a broad enough reading on selected market; using fewer than 3  can result in a considerable loss of data while using more typically becomes information overload or redundant analysis.

It is very important to select a time frame that will reflect your strategy.

A long-term trader who holds positions for months will find little use in analyzing a 15-minute, 60-minute and 240-minute combination.

At the opposite of this spectrum, a day or intraday trader who holds positions for hours and rarely longer than a day would find little advantage in daily, weekly and monthly arrangements.

Now, that is not to say that the long-term trader would not benefit from keeping an eye on the 240-minute chart or the short-term trader from keeping a daily chart in its repertoire, but these should come at the extremes rather than anchoring the entire range.

THE PRINCIPLES OF MULTIPLE TIME FRAMES 

  • Every time frame has its own structure.
    The higher time frames overrule the lower time frames.
    Prices in the lower time frame structure tend to respect the inflection/decision points of the higher time frame structure.
    The Inflection/decision points acting as support/resistance created by the higher time frame’s activity (prices) can be validated by the action of lower time periods.
    The trend created by the next time period enables us to define the tradable trend.
    What appears to be chaos or noise in a particular timeframe, appear as orderly in another time frame. Longer timeframes tend to smooth action.

IMPORTANT:

Financial products present very different Characteristics. Some trading in narrow and somewhat mild ranges  while others in large and violent way.

Please take volatility and product behavior into consideration before selecting products and timeframe

Long-Term Time Frame - Trend direction

The longer time Chart helps to establish the dominant trend.  I will use a metaphorical example here:

Let's compare a Cargo Vessel to a Speed Boat.

The Cargo Vessel is powerful, heavy, difficult to maneuver, can travel long distances, withstand large storms and requires effort to get moving.

Once in motion, it also takes effort and time to stop. Small boats are the complete opposite.

Trends are similar to Cargo Vessels when they appear on long time frame charts. Once they have been established, they tend to last.

And, ... They tend to last longer than expected!

The large time trade frequency information serves to keep us at the right side of the trend. It helps us to navigate alongside large Vessels.

Positions should not be executed on this wide angled chart, but the trades that are taken should be in the same direction as this frequency's trend is heading.

This doesn't mean that trades can't be taken against the larger trend.

What must be clear here is that,going against it, will  have a lower probability of success.

The profit target should be smaller than if it was heading in the direction of the overall trend.

In general trading or investing following the dominant trend yields higher probability of success. Making mistakes in the direction of or in sync with the dominant trend allows us second chances. It tends to be a bit more forgiving.

This doesn't mean that trades can't be taken against the larger trend; it is possible and there are many accomplished counter trend trade strategies.

These strategies require far more skills and timing. In general they have a lower probability of success and the profit target clearly defined.

They are often smaller than if it was heading in the direction of the overall trend.

Below, a Monthly Nasdaq Graph:

 

Trade Location - Intermediate Time Frame

In any trend there are corrections and deviations which can represent good opportunities to get on board and follow the trend. , Smaller moves that occur inside the broader trend become visible within the intermediate time frame.

This is the most versatile of the three frequencies because a sense of both the short-term and longer-term time frames can be obtained from this level.

This is the timeframe to be monitored constantly.

It is the navigation instrument, the market compass if you will.

Below, we are zooming in by analyzing the Nasdaq Weekly Graph

 

Trade Execution

Trade Execution - Short-Term Time Frame

The last step in the process is trade execution.

Trades should be executed on the short-term time frame. As the smaller fluctuations in price action become evident, a trader is better equipped to find an attractive entry point.

Here we are looking to increase precision.

The direction has already been defined by higher timeframe analysis.

Short- term timeframes are sensitive. These timeframes respond to news and announces making them erratic and volatile.

The lower the time frame, higher is the sensitivity to price movements.

Unless one is trying to Scalp markets, it is wise to select time frames that smooth noise up to the extent that will allow for precision, yet smooth price behavior.

Concentrate on price development instead of single prints or ticks.

Here we would make the final decision by focusing on the Nasdaq Daily Graph:

 

Putting It All Together

When all three time frames are combined to evaluate an instrument, a trader will  improve the odds of success for a trade, regardless of the other rules applied for a strategy.

Concentrating on a Top Down analysis, will filter trades and help reduce mistakes. It will keep one focused on dominant trends instead of trying to catch every possible move.

This alone lowers risk as there is a higher probability that price action will eventually continue on the longer trend.

Applying this theory, the confidence level in a trade should be measured by how the time frames line up.

For example, if the larger trend is to the upside but the medium- and short-term trends are heading lower, cautious shorts should be taken with reasonable profit targets and stops.

Alternatively, a trader may wait until a bearish wave runs its course on the lower frequency charts and look to go long at a good level when the three time frames line up once again. (To learn more, read A Top-Down Approach To Investing.)

Another clear benefit from incorporating multiple time frames into analyzing trades is the ability to identify support and resistance readings as well as strong entry and exit levels.

A trade's chance of success improves when it is followed on a short-term chart because of the ability for a trader to avoid poor entry prices, ill-placed stops, and/or unreasonable targets.

Nasdaq Example

Here are the long term charts for the Nasdaq Composite.

Nasdaq Weekly 1

This is a monthly chart of the Nasdaq Composite Index. .

The index was probing historical highs; in fact it was probing the highest levels ever registered.

The last time the Nasdaq has reached such high levels was during the dot-com Era /bubble in late 90's early 2000's. This level should be considered  critical for most market participants from a fundamental and technical standpoints.

For the valuation inclined investors, it could mean that the market is roaring high, but valuations may be two expensive and warn caution as we are approaching critical levels and some automatic reactions may take place.

For the Momentum inclined investors, there is a new high in sight. Markets could break out and move stronger, breaking the historical highs and extending to register new highs.

Trend Followers will try to push prices higher as that is what the principles tell them to do.

There are infinite number of arguments to justify different opinions. They can be fundamental, technical or statistical.

Whatever the argument is, the picture above helps to illustrate some things:

  1. There was supply in this are in the past. Will that repeat itself again? Nobody Knows!
  2. The Primary trend is up! No discussions here. There is mutual agreement in this front.
  3. The market is spending considerable time in this area. So far, it means acceptance. Acceptance leads to continuation in many cases.
  4. Volume has decreased during the last attempts. Common wisdom dictates that when there is lower interest, there is a chance for a correction. To explore that we will look at the weekly chart.

Nasdaq Weekly 2

What the weekly charts confirms is the long bias at this point.

One could argue that the movement is over-extended and the historical level may provide some serious resistance.

The very honest answer to this argument is simply, So What?!

Markets can - and often will - go on what seems to be forever, before it decides to turn around.

It will be Super Over Extended!

The entire world will be shouting it is bound to fall, but it will continue to no avail.

There were a Pretoria  of reports and arguments warning of an upcoming disastrous correction. Well, it didn't matter. They have been proved empty arguments.

What defines what markets will do is the combination Money flowing into markets and investor's appetite. The rest, doesn't matter.

That is it!

The daily market below showed that at that time, market participants were positively biased towards market performance.

The movements may have been less pronounced, however, weren't violently nor corrective. So for investors, the case for a long bias remained intact from a technical stand point.

Nasdaq Daily 1

As long as there were no signs of  weakness or fractures in economic data, investors were happy to invest in stocks.

Upon signs of stress, one would start to build a case for portfolio adjustments, profit taking, long liquidation and reduced risk exposure.

Would money managers liquidate all at once?

I don't think they would unless there were some strategical arguments for such actions - i.e. profit targets being met and new objectives in mind.  Otherwise, status quo!

As long as the situation proves beneficial to portfolios, they will continue to support the cause.

Now, please remember: I am not implying here that one should simply disregard data and analysis!

I don't!

That is not what I mean.

All I am doing is interpreting the data according to what I have been trained for in the past.

Before trying to decide what the market will do and make hasty decisions, you should find a philosophy and methodology that provides a framework. Once in place, you should use it for your investment analysis and try to synchronize with market behavior as evidence.

What is the dominant majority is saying right now?

Take a look and decide by yourself.

The same picture will have thousand interpretations.

There is merit to every single investment strategy and argument.

In fact, history has proven that there is place and time for each faction - bulls or bears - to celebrate.

If someone find reasons to start to short the market believing it is overextend and reaps fantastic results, all I one say is Congratulations!

Being a contrarian pays off big time!

It takes mental fortitude discipline and capitalization to do so.

It is a matter of perspective and of course risk tolerance, capitalization, and expectancy.

Regardless the style or time horizon one decides to follow, the principles remain the same.

Find an opportunity, weight the pro's and con's and finally explore it.

Place the bets and accept the risk!

That is it!

If the risks involved are justified and there are decent premiums to reward the risks involved, go ahead and take the jump.

However, if risks are unjustified, let it go!

Take a break, enjoy life and do other things.

Wait patiently until a situation  provides you with an opportunity. Once conditions fulfill or are aligning with your requirements and meet your accepted levels of risk, Go FOR IT!

Short Term Example

Trading Frequency and Holding periods

The trading frequency and length are the main differentiation here.

The length of trades selected will generate the idea and become the Intermediate or Medium timeframe.

It will become your trading standard.

From there, a shorter term time frame should be chosen and it should be at least one- third or one-fourth the intermediate period.

Let's explore the same Nasdaq example but from a Day trader perspective:

- Imagine you have decide to become a day trader.

For your  intraday trade, you would decide to simple trade for a couple of points, not holding a trade longer than one hour.

In order to find opportunities, you selected 60 minutes as the trading time frame.

The 15-minute will become the small time frame (Trigger) and the 240 minutes the long time frame to define risk and targets.

That is an example, it is not a rule!

What is very different here is the process.

The analysis and the overall assumptions.

Nasdaq 240 minutesNasdaq 60 minutesNasdaq 15 minutes

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