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Become a Better Trader: Respect the Trends

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Markets don't change courses overnight.

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I figured after the worst January in history, now was a better time than ever to revive my Steps to Becoming a Better Trader series. With so many being led astray by traditional Wall Street or by phony financial advisors, it's time you were taught the truth.

I'm often asked how I successfully sidestepped the worst market in 70 years; more often than not, I simply say "I listen to the tape and respect what it says." This of course includes numerous small items, which I will lay out over the next few days.

Understand the Flow of the Big River

One of my favorite trading tales involves a very wise, veteran trader who, when asked his thoughts on the market, would simply respond by saying "It's a bull market," or "It's a bear market." Younger traders simply seeking out a hot tip from the seasoned pro would often leave discouraged - or even annoyed, believing they were being fed a line. JL himself didn't understand until years later the wisdom that was actually being dispensed with those words: The veteran was simply relaying the path of least resistance, or the trend for the general market, and therefore giving the trader an incredible edge in determining one of the many variables that makes up stock trading.

Unfortunately, over the years, this basic and foundational principal has lost some luster due to products or individuals attempting to sell get-rich-quick trading systems by simply following trends or channels. As sad as it may be, it doesn't negate the fact that understanding the general market trend is the first and most important arrow in a trader's quiver.

Traders should equate the general market to that of a big river with individuals stocks as floating logs. If ones objective was to ride in the general direction of the current, they would not stand on the bank looking for a log that was bucking that trend? Furthermore, even if they found one that temporarily headed in the wrong direction, more than likely it would only be a matter of time before the log reversed course and also headed in the way of all the other logs.

Understanding this basic tenet is paramount to successful investing, yet so many refuse to truly grasp its importance. In August 2007, I encouraged readers to avoid banks - and received quite a few emotional responses from those telling me I was slightly off the mark. OK, so that's putting it mildly, but you get the idea. What I saw here were stocks like Citigroup (C), Wells Fargo (WFC) and Bank of America (BAC) breaking multi-year trends or a river that was changing its course. I didn't grasp the magnitude of what was coming down the pike, nor did I care to guess, I simply respected the trend change and stepped aside.

Today, I see so many trying to call the bottom in stocks like Apple (AAPL), Google (GOOG), or sadly even the financials; in reality, these trends are still down, and, until they change, must be respected.

Traders would be wise to understand there are 3 directions a market can travel; up, down or sideways. As long as we trade stocks, this will be true - and just as valuable as Livermore's seasoned trading friend's advice was then it would be today.

Markets, like rivers, don't change courses overnight - or even in a few days. It often takes many months if not years to properly establish a trend. Simply pull back any weekly chart over the past couple years and assess where the trend is going. If you aren't quite sure, then more than likely cash remains the place for you.

Understand this basic, yet key, principle of trading, and you will already be well ahead of most.
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