Using Trendlines: Why Kids Make Great Traders

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As traders we have a tendency to surround ourselves with the latest and greatest thingamajig in hopes of making more money. But complex is not always better. Sometimes "complex" can lead to "confusing" which gives way to "frustrating" and maybe even "busting your account."

Don't get me wrong. I'm not against technology in trading. However there are some basic principles that must be adhered to if you're going to make money in this game. The good news is the basics are simple: simple enough for an eight-year old to understand yet powerful enough to be the backbone behind every successful trader.

THE TREND

How many times have you heard "the trend is your friend"? Knowing the trend and sticking to it is the easiest way to make money trading. But if it is that simple why is it that 90% of traders lose money? The obvious answer is that 90% of traders can't correctly define the trend or, if they know the trend, choose to trade against it.

THINK LIKE A KID

Identifying the trend is not difficult, especially if you think like an eight year old. Put a chart in front of an eight year old they can easily tell you if the market is going up or down. Here is what an eight year old sees: if the market begins in the lower left corner of the chart and finishes in the upper right corner it's an uptrend. If the chart begins in the upper left and finishes in the lower right it's a downtrend, with only a few minor corrections along the way. If you have more than two trends on a chart you don't have a trend at all, you have a range.

Simple? Yes. Does work? Absolutely! The bigger question now is: once you know the trend, will you trade with the 10% going along with it or continue to trade with the other 90% losing money by going against it?

CONNECT THE DOTS

When I was eight I used to love the connect-the-dots puzzle books. There was something magical about drawing lines between the dots to reveal a picture that wasn't there a moment ago. Trading is similar. Sometimes all we need to do is connect-the-dots like an eight year old to get a picture of what is happening.

Trendlines are a great way to connect-the-dots, but I'm going to show you a variation which will alert you to changes in trend. Normally trendlines are drawn along the swing lows in an uptrending market and across the swing highs in a downtrending market. This is good for seeing where the buying/selling is taking place but not always so good for identifying when a trend has changed.

A VARIATION

Next time try this: in an uptrending market draw a line connecting the swing high instead of the lows. By doing so you will immediately see when market momentum has shifted because your connect-the-dots will have shifted too! Naturally you would do the opposite in a downtrending market and connect the swing lows instead of the highs. Do this and you'll never get caught by a reversing trend again.

ENTRY

When was the last time you saw an eight year old swerve to miss a puddle with their bicycle? Or how often do you see a child hesitate to jump into a swimming pool? Children are naturally fearless. It's only as adults that we learn to second guess ourselves, but we could take notes from how 8 year olds approach things.

As an adult our hesitation can cost us. Be honest, how often have you talked yourself out of a good trade? Why did you do that? If you're like most traders you either didn't have a solid trading plan or the will to stick to the plan, or both. Next time you get a signal that meets all your trade criteria think like an eight year old and be fearless - take the trade - you might be pleasantly surprised at the results!

GET USED TO BEING WRONG

Eight year olds are very much like traders, they think they know everything but they still end up being wrong, a lot. The difference between eight year olds and traders is that the eight year old gets over being wrong and gets on to the next thing; whereas traders take every bad trade personally - but there is a solution! The best way I've found to get over being wrong is to use proper money management techniques to begin with.

If you're an eight year old shooting marbles (do kids still do that?) you don't put all your marbles into play only to watch your competitor take them all. If you're smart you limit the number of marbles you risk so that you still have some left to play the next day. The same is true for trading - don't risk too many marbles on a single trade.

Proper money management means not risking more than you can afford to lose on any trade. This means limiting your risk to 2% of your account, but anything less than 5% is considered prudent. Proper money management allows you to take a loss without damaging your account to the point where you can't trade anymore.

Limiting your risk exposure is exactly what professional traders and money managers do. They know the math. They know that there is a definite statistical possibility that they could take 10 losing trades in a row! Limiting your risk exposure is the only way you'll be able to preserve your account when a bad streak hits.

BE FEARLESS WITH YOUR ENTRIES

So there you have it. Learn to trade like an eight year old: determine the trend and stick to it, be fearless with your entries and use proper money management. Do this and you'll be well on your way to the trading success you've been looking for. After all, it's so easy an eight year old could do it, why not you?

Looking for trading ideas? Read our daily Markets section here.

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ALSITRADER: Why Kids Make Great Traders http://t.co/6AunUZbQDA
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ALSITRADER: Using Trendlines: Why Kids Make Great Traders http://t.co/1l8JVqYh2I
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ykory: It's a great idea to use in practical trading. Personally I always look at the angle of a trend line and check moments when it changes. The angle change conveys a message that the trend is losing momentum.
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LaneMen: Nice article Erich! Thanks....
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About the Author

Erich Senft has been actively involved in the futures markets for 17 years. He is a registered CTA, and the man behind: www.SupportandResistance.com. Click here for a day trading money management tool that illustrates the above points in the article.

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