The Top Strategy Used By Successful Traders and Investors
Here's how to follow a trend, using this Bitcoin ETF as a guide.
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No investing or trading strategy is inherently superior. What works best depends on the individual and their ability to find the right stocks and employ a disciplined methodology. The question that needs to be asked is: What strategy will deliver the biggest payoff if your stock selection is good?
My answer is trend-following. I believe that a trend-following strategy has the potential to produce the best returns for market players that employ it correctly. Here I will explain my reasoning and then use the case of the Bitcoin exchange-traded fund, IBIT IBIT, as an example.
What Is Trend Following?
Trend following is the stock market equivalent of Newton's first law of motion, which states: "A body in motion remains in motion at a constant velocity unless acted upon by an external force." In other words, an object (or a stock) will continue to move in the same direction unless something pushes or pulls on it to change its motion.
Stocks may move very randomly in the short term, but as the time frame increases, there is a very strong tendency for some sort of trend to become apparent. Trend followers attempt to catch the meat of this movement.
What is unique about trend following is that the focus is on managing the movement of a stock rather than trying to predict it. You stay with the trend until it ends, and don't try to guess when that might be. One drawback of trend following is that you will suffer some losses when the trend does end. Since you aren't trying to time a top, it is necessary to sit and wait for one to actually occur.
Like most trading concepts, trend following is fairly easy to understand, but effective execution can be very difficult. Michael W. Covel, the founder of TrendFollowing.com, defines trend following as a trading strategy that emphasizes discipline, risk control, and precise trading rules over predicting market directions.
The first step in the trend-following approach is to find a stock that is starting to trend. If market conditions are strong, that won't be too difficult, but I will try to differentiate by doing some fundamental analysis that suggests that there is adequate upside valuation for the stock to trend for a while. Trend following is primarily a technical approach, but understanding the fundamentals can make it easier to stay disciplined.
The most difficult task in trend following is determining when the trend has ended. That will depend on time frames and volatility. If you are using a longer-term time frame, then you have to allow for higher levels of volatility. It is also necessary to recognize that volatility can vary significantly, and overall market conditions will have an impact as well.
IBIT Example
A good example of an asset that is best traded using a trend-following approach is Bitcoin. I'll use the IBIT exchange-traded fund as a proxy for an actual Bitcoin. Bitcoin does not have any valuation issues to confuse matters. It trades solely on the basis of supply and demand. Historically, there have been some very strong trends in either direction.
My thesis for a trend trade in IBIT is that the election has shifted sentiment and that the more positive sentiment is likely to start greater acceptance by institutional investors who will feel it is required for them to have some exposure to the asset class.
The chart of IBIT above starts when the bitcoin ETFs were approved by the Securities and Exchange Commission in January 2024. As you can see, there was a downtrend that lasted from March through October, followed by a recent breakout and the beginning of a new trend.
The most important issue here will be the level of volatility within this new potential trend. There was about 20% volatility in the recent downtrend, so we are dealing with some very sizable moves. If you can't handle that much volatility, then you need to use shorter time frames or different trading vehicles. The upside of high levels of volatility is that there is greater potential for big upside moves as well.
I'll keep you posted on how this trade develops.
Trend following is an extremely powerful strategy, and it can work in tandem with other approaches, especially fundamental and value investing. The key is staying disciplined and following the rules. Don't let emotions lead you astray.
At the time of publication, DePorre was long IBIT.
