TREND
by George Kleinman
Editor, Commodities Trends
April 30, 2007

A successful trader once told me, “If you can determine the trend of a market, you’ll make money.” It’s simple, yet profound.

The reason you’ll make money when you correctly identify the trend is, even if your timing is off, many times the trend will bail you out. However, even if your timing is perfect going contra-trend (trying to pick tops and/or bottoms), you must be extremely nimble in booking profits. They’ll be fleeting because, over time, the trend will eat them up.

Just as it’s much easier to swim with the current than against it, it’s generally much easier trading with the trend than against it. The trick is how to determine the prevailing trend, and, just as important, how to determine it early enough to reap the benefits.

It’s a paradox that the trend is always up at the top and always down at the bottom. And it’s a fact that the most money will be made by those who can pick tops and bottoms. I admit I’m unable to do this with any degree of accuracy; I know no one who can. But the good news is we don’t need to capture a full move to make money. A piece of the move will do just fine.

Today, we’ll get into one method of market-trend determination and how to potentially stay out of trouble. I plan to use the KISS (keep it simple, stupid) method here because simple is generally better.

If you follow market news at all, you know the trend of the Dow Jones Industrials Average is “up” right now. There’s no way to dispute that fact because the Dow has just registered all-time highs. There are also statistical means of saying what we know to be true.

Statistics are most useful when we’re unsure of the trend; the statistic we’re going to use here is the 50-day exponential moving average (EMA).

The daily chart of the Dow is in green (closing price in the green box on the right-hand scale) with the 50-day EMA in red (closing price of the 50-day in the red box on the right-hand scale). In KISS terms, the Dow is in an uptrend because the market is currently trading above its 50-day.

June Dow Futures



Source: Commodity.com

So, should we buy the Dow right now? You can eyeball it and see that it’s way above its 50-day (4 percent is significantly above). Therefore, if we risk to a move below the 50-day, we’re assuming a significant risk.

I’m not advocating top-picking; after all, the trend is up and it could move higher. I’m just pointing out that the risk is high now. From a risk-to-reward standpoint, this may not be the best of trades.

What if you had bought the Dow when it last crossed above the 50-day, closer to 12,500? You'd be up more than 600 Dow points now, and your risk at that time was minimal. If you had bought it on that last cross above, and are still holding, your dilemma now is when to take your profit. And this is the best kind of dilemma to have.

Let’s turn our attention to a market in a confirmed downtrend, cotton. We know cotton is in a downtrend because it registered new contract lows last week. The chart below is sort of a mirror image of the Dow chart above.

December Cotton



Source: Commodity.com

Should we short cotton now? I’m not suggesting buying it yet because the trend is down, but it's “cheap” and more than 5 percent below its 50-day, so the risk of shorting is high right now. It’s not among the best potential trades.

What if we had sold on the first break of the 50-day, back on April 9 just above 5,800? This is what I did, and this is why the 50-day helped me out. I was long cotton and bullish at that time because the planted acreage is lower than it’s been in three decades. 

This fact should be bullish, but the 50-day kept me out of trouble here. By selling out on the first break under, I locked in a small profit on that trade. More important, I prevented a large loss.

Should we have gone short that day? Sure, we’d now have a position up nearly $2,000 per contract in the ideal world. In the real world, it’s hard to go against your fundamental bias. However, once again the 50-day was much smarter than I was; another way of putting it is, “The market is always right.”

Don’t get me wrong--I’m not saying this method is foolproof. There certainly will be false signals. For example, take a look at sugar, which is in a well-defined downtrend today. But note the glaringly false buy signal in early March on that one-day spike above 11.

July Sugar



Source: Commodity.com

What I’m saying is this simple indicator will, on balance, keep you out of trouble and will, by default, position you on the right side of major moves.

Copper is in a well-defined uptrend right now:

July Copper



Source: Commodity.com

As is the euro:

June Euro



Source: Commodity.com

How about choppy markets? What’s the trend in gold right now?

June Gold



Source: Commodity.com

Based on the 50-day, despite the recent correction, the trend in gold remains up, and it should be played accordingly.

As bullish as I am on corn for the long haul, the 50-day is telling us the trend is down at this time.

July Corn



Source: Commodity.com

The key here is to look for markets that are close to their 50-day EMA. This will alert us to potential changes in trend (when the 50-day is crossed) or provide confirmation the trend is still intact (if the 50-day isn’t crossed).

The advantage of taking a trade just as the 50-day is crossed is the risk on the trade can be defined down. In other words, if you risk to a close on the other side of the red line, your risk per trade is comparatively much lower than taking a trade well above or below the red line. There will be times when your risk is quite low but the potential reward is major. (Just take a look at the first five charts.)

Markets that have recently crossed or are close to their 50-day EMAs include oil (buy signal) and cocoa (sell signal). There are many others; all you need to do is look.

June Crude Oil



Source: Commodity.com

July Cocoa



Source: Commodity.com

One of the big keys to success in the markets, as well as in life, is to just not fight the prevailing trend. To put it another way, go with the flow.

George Kleinman is editor of Commodities Trends.

© 2007 George Kleinman
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Futures and futures options can entail a high degree of risk and are not appropriate for all investors. Commodities Trends is strictly the opinion of its writer. Use it as a valuable tool, not the "Holy Grail." Any actions taken by readers are for their own account and risk. Information is obtained from sources believed reliable, but is in no way guaranteed. The author may have positions in the markets mentioned including at times positions contrary to the advice quoted herein. Opinions, market data and recommendations are subject to change at any time. Past Results Are Not Necessarily Indicative of Future Results.

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