From Trading for a Living, by Alexander Elder (Page 80)


Traders try to profit from changes in prices: Buy low and sell high, or sell short high and cover low. Even a quick look at a chart reveals that markets spend most of their time in trading ranges. They spend less time in trends.

A trend exists when prices keep rising or falling over time. In an uptrend, each rally reaches a higher high than the preceding rally and each decline stops at a higer level than the preceding decline. In a downtrend, each decline falls to a lower low than the preceding decline and each rally stops at a lower level than the preceding rally. In a trading range, most rallies stop at about the same high and declines peter out at about the same low.

A trader needs to identify trends and trading ranges. It is easier to trade during trends. It is harder to make money when prices are flat unless you write options, which requires a special skill.

Trading in trends and in trading ranges calls for different tactics. When you go long in an uptrend or sell short in a downtrend, you have to give that trend the benefit of the doubt and not be shaken out easily. It pays to buckle your seat belt and hang on for as long as the trend continues. When you trade in a trading range, you have to be nimble and close out your position at the slightest sign of a reversal.

Another difference in trading tactics between trends and trading ranges is the handling of strength and weakness. You have to follow strength during trends -- buy in uptrends and sell short in downtrends. When prices are in a trading range, you have to do the opposite -- buy weakness and sell strength.