“Essentially, whatever you find will be as true 10 years from now, 20 years from now, 30 or 50 years from now as it is today and as it was 50 years ago. And if you can put your finger on those truths, then you’ve made a contribution.” — Jim Collins
“In any case, thanks for a great site and a lot of useful information. I just like to read the sarcastic pages on how uninformed people have no clue that highly paid professionals have no clue either. It is worth publishing a book. Merci beaucoup.” — Edmond (web visitor)
There are literally thousands of trading approaches promoted online and offline. Below are examples of trading approaches that the world’s best trend followers avoid within their trading systems:
- %R Oscillator
- Astrology
- Candlesticks
- Cycle Prediction
- Delta Moon Prediction Techniques
- Elliott Wave
- Fibonacci
- Fuzzy Logic
- Gann
- Genetic Algorithm
- Geometric Angles
- Golden Spiral
- Granville’s On-Balance Volume
- Island Reversals
- Moon Phases
- Neural Networks
- Planetary Motion
- Point and Figure Charts
- Relative Strength Index
- Seasonality
- Support/Resistance
- Weather
- Proper thinking about entry/exit…
It is guaranteed, for example, legendary trader John W. Henry is not using Planetary Motion to determine when to buy or sell and more importantly how much to buy or sell.
Pattern Trading
These patterns are the world of CNBC analysts. Top trend following traders understand so-called “predictive patterns” are not the key to success:
- Reversal Patterns
- Continuation Patterns
- Head and Shoulders
- Symmetrical Triangles
- Inverse Head and Shoulders
- Ascending Triangles
- Triple Tops
- Descending Triangles
- Triple Bottoms
- Double Tops
- Double Bottoms
Support and Resistance
What is support and resistance? One marketing pitch:
Support, resistance, and trendlines are at the very heart of technical analysis. That’s because they’re based on the basic economic principles of supply and demand. The tools you’ll receive in this package give you a consistent and objective method of determining where these lines should be drawn on your charts. Implement the principles of supply and demand in your chart analysis and develop a consistent and objective method of placing lines on your charts.
Support and resistance is the heart of technical analysis? Learn how to draw trendlines? Trend followers do not do this. Trend followers work within the here and now. They make decisions based on today’s price. Support and resistance might make for a good story in a magazine, but there is no basis to believe that it is anything more than another futile attempt at prediction.
What These Approaches Have in Common
The approaches listed above span an enormous range of apparent sophistication. Astrology and planetary motion are dismissed on their face by most traders. Genetic algorithms and neural networks sound cutting-edge. Elliott Wave and Fibonacci carry mathematical credibility. Gann’s geometric angles have a mystical precision about them. Support and resistance is presented as fundamental economics. But all of them share one structural property: they purport to predict where price will go rather than react to where price is.
The prediction problem applies equally to the intellectually sophisticated and the intellectually naive approaches on the list. A neural network trained on historical price data will find patterns and produce predictions. Those patterns reflect the specific historical sample it was trained on. When the future produces market conditions not well-represented in the training data, the neural network’s predictions fail just as surely as the astrologer’s planetary alignment predictions fail. The sophistication of the pattern-recognition apparatus does not change the fundamental problem: the future is uncertain, and pattern recognition applied to the past does not reliably predict the future.
Support and resistance is the most widely used approach on the list, which makes the critique particularly important. The supply and demand framing is compelling: prices rise when buyers outnumber sellers (support) and fall when sellers outnumber buyers (resistance). The problem is that the specific price levels at which this transition occurs in the future cannot be reliably identified from past price behavior. Markets regularly break through “support” and “resistance” levels without reversing, because the buyers and sellers who created those levels in the past are a different set of participants from those who will determine future price direction.
Jim Collins’s opening quote identifies what the world’s best trend followers have found instead: truths that hold over 10, 20, 50 years. The truth that markets trend, that cutting losses and letting profits run produces positive expected value, and that volatility-based position sizing preserves capital through adverse periods are those truths. They were true 50 years ago. They are true today. They will be true in 50 years. Planetary motion patterns and moon phases are not.
Frequently Asked Questions
Why do trend followers avoid Fibonacci and Elliott Wave despite their mathematical appearance?
Because mathematical appearance is not evidence of predictive power. Fibonacci ratios are derived from a sequence found in nature and have no documented reliable relationship to future price turning points. Elliott Wave requires subjective interpretation of wave counts that two practitioners routinely count differently from the same data. Neither approach produces objectively defined, mechanically testable signals that hold up under rigorous historical testing across diverse market conditions. The mathematical appearance is the appeal. The absence of documented edge is the reality.
Why is support and resistance not reliable despite its logical appeal?
Because the participants who created past price levels are not the same participants who will determine future price direction. A price level where many buyers entered in the past may produce buying again, or may produce selling from those buyers taking profits, or may be irrelevant if the participant base has entirely changed. The supply and demand logic is correct in theory. The specific price level prediction is unreliable in practice because the future’s participant behavior cannot be reliably inferred from the past’s participant behavior at those levels.
What distinguishes the approaches trend followers do use from those on this list?
The approaches that work are reactive rather than predictive. A price breakout above the 20-week high is an observable fact about current market conditions, not a prediction about future conditions. It fires when the condition is met and produces a position in the direction the market is already moving. The approaches on this list all attempt to predict future price behavior from patterns, cycles, or indicators derived from the past. The distinction is not about indicator complexity but about whether the signal reacts to current conditions or predicts future ones.
Trend Following Systems
Want to learn more and start trading trend following systems? Start here.
