«

»

Feb 09

The Trend Follower’s Dilemma

This morning as I picked up my copy of IBD and eyeballed the charts for any opportunities I may have overlooked, (new color scheme for the charts by the way, they now show down bars in red, interesting timing), it dawned on me that I often see stocks that have just had a huge move, gapping higher on earnings or news events, and when I look more closely I often surmise that I’ve missed the move so I pass on it and look for others.

This week’s example would be Fleetcor ($FLT), already in a solid uptrend, and up over 60% in the last 8 months, it vaulted another 11% on Friday in huge volume after beating on the top and bottom line and raising FY guidance.

AlphaCapture

Would you buy it here?

It’s perhaps a lot easier for most people to say ‘I’ll buy it when it pulls back’ and put it on their watchlist. That was certainly my first reaction.

But here’s the thing.

I quickly realized there’s a stock I’m already long that just had an even bigger move, LinkedIn ($LNKD).

AlphaCapture

I posted here about the solid trend and my comfort being long into earnings. Now we’re sitting pretty, and I have no plans to sell it, I’m just riding the trend.

So here’s the question, isn’t the fact that I wouldn’t sell it here, effectively the same as buying it here?

It’s an interesting dilemma for momentum traders and trend-followers. Because if I’m happy to hold onto to the $LNKD long, shouldn’t I be just as relaxed about buying $FLT here?

In nominal terms what I make or lose on $LNKD from this point forward is no different than if I were buying it for the first time at Monday’s open. The difference is purely psychological, I’m already sitting on a nice gain so I ‘feel’ like I’ve got this cushion of comfort to let it ride, but as we’ve discussed before, the point of invalidation would be no different regardless of my profit or loss on the trade.

Just for fun let’s play ‘what happened next’ with a recent large gap move in Netflix ($NFLX).

AlphaCapture

Could you have bought something that was up 42% on the day?

If you don’t have a system, probably not. And if your system did tell you to do it, would you have the discipline to follow its signal? Look what happened. For anyone who bought it that day it’s now already up another 23%.

Look at charts like $FLT, $LNKD, $NFLX, and ask yourself if you got a signal to buy them at Monday’s open would you take it?

Then ask yourself if you were already long and had caught those big moves would you still be holding on to your position?

The answer to both questions should be the same.

These are first-world trading problems for sure. But they’re important questions to ask yourself because they’re why we develop trading systems that mirror our beliefs. Systems are designed to remove our biases or opinions from the equation. If you don’t have one in place then these dilemmas will present themselves repeatedly.

Make these decisions be part of a systematic process so you can know regardless of the move that came before, the logic and reasoning has already been done for you, and it’s not an emotionally charged trade.

In fact, as I’ve mentioned before there’s something to be said for a system that trades when you wouldn’t. Anything that runs counter-intuitive is probably going to make better decisions than you could yourself and will already be one step ahead of the vast majority of market participants.

Imagine all scenarios, prepare for them, and let dilemmas like these be someone else’s problem.

 

3 comments

  1. Andrew Thrasher (@AndrewThrasher)

    Great article. It would be tough buying on the gap up but your right about sticking to a plan/system. Thanks for your insight.

    1. Jon Boorman

      Thanks Andrew

  2. Brent Hause

    love it

Leave a Reply