Follow the (Right) Crowd for High Probability Trades
Do you want to increase your chances of having a successful trade?
Here’s how to do it:
1. Choose a stock that shows a possible new uptrend
2. Find out to which market sector this stock belongs
3. Check how the market sector is doing: are many stocks trending up?
4. If more than two-thirds of the sector stocks are trending up, buy that stock
Why does that work?
Because… we are following the crowd. If many stocks already show a positive trend, then more investors want to join and benefit from this price move.
They will look for more opportunities in the same industry. It’s like a positive feedback loop.
The success rate is important… right?
The success rate is not the most important part of a trading system – risk management is!
But having said that, once you have your portfolio protection in place, it’s time to consider something else: optimization.
There are many ways to optimize, and some are complex and dangerous. For example, when searching with sophisticated data mining tools for ways to optimize parameters, then there is the danger of overfitting.
We will not get into this today.
Instead, I will discuss a very straightforward, no-fancy-tools-needed way to give your trading system a nudge!
Boosting success rate can have a dramatic effect on portfolio growth…
Here’s an example:
Imagine you make money 50% of the time, and the average winning trade makes 40% more money than you risked. For every losing trade, you lose what you risked.
If you risk on each trade $500, then:
• Each winning trade returns $700
• Each losing trade costs $500
On average, each trade grows your portfolio by $100. If you make 100 trades per year, that’s $10,000 per year.
There are three ways to boost growth:
1. Make more money per trade
2. Trade more often
3. Improve your win rate
Today we will look at (3). What would happen if the win rate increases to 55% (from previously 50%)?
With 100 trades per year, that’s 55 winning trades and 45 losing trades:
Yearly Growth = 55 x $700 – 45 x $500 = $16,000
Nice, huh?! Even a small percentage change in your success rate can make a large difference in yearly return.
So, how to boost that win rate?
Let’s look at an example:
The below chart shows a price curve that has a downtrend, but it might be at the point of changing into an uptrend.
Let’s assume our trading system tells us that all indicators are there for a trend reversal (like breakout or cross-overs from moving averages). So, we could go ahead, set a stop price, calculate the number of shares we can buy without exceeding our risk settings.
Now let’s look at what the industry to which this company belongs is doing on the markets.
The market sector is doing great.
79% of all stocks in that sector are currently trending up. Our chosen stock has been in a downtrend, then switched to a sideways trend, and now starts to be in an uptrend.
My interpretation would be that this stock is joining the rest of the crowd… moving into a strong uptrend that is already existing in that market sector.
Now let’s look at Scenario B:
The market sector is not doing so well.
Two-thirds of the stocks show a solid downtrend, and only 14% are in an uptrend.
There are two ways looking at that:
1. The sector is up for a reversal in trend and our chosen stock is part of the early bird group
2. The sector downtrend continues and the indicators were showing us a “fake” reversal
In which scenario are you more convinced about your trade? A or B?
Not convinced that following the crowd is a good thing?
That’s cool. There is no right or wrong answer because it’s not black and white. It’s about probabilities.
Imagine your trading system did not give you any stock to choose. But you still want to buy one – so you decide to buy one randomly.
From which sector would you randomly choose a stock to buy? A or B?
Before answering that, two quick reminders:
• You have no other information available at this point to make a decision
• Trends tend to continue in the stock markets
Here’s an example of a downtrend that continued for a while (that’s real historical pricing data):
If I had to buy a random stock, I would go for Sector A. My chance of getting a positive trade is at 79%, based on the available data.
If choosing Sector B, my success rate is only 14%…
It could still happen! Just not very often.
How to find out about market trends?
That’s a bit tricky, but no worries, I got your back on this one!
I spent hours on researching about company trends, market sectors and industry trends so you don’t have to! And I packed it all in an easy to use, web-based tool that you can access from your computer, tablet or smartphone.
You can access it via the download section at the end of this article.
Once you receive the link, bookmark it so you can always access it when needed. The content will get updated once per week (usually on Saturdays).
To increase your success rate, choose stocks that belong to a market sector that supports your idea – in our case, that an uptrend is more likely than a downtrend.
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Market Trends Web App
Click on the image or button below to get it!
By using the app, you will always know what the current market trends are!
Remember: the trend is your friend!
Get the link and bookmark it so you have it ready for every stock that you look at.