These 'Clues' Are Critical to Timing the Trend

Editor's note: Longtime DailyWealth readers know we always want to stick with the trend. So in today's Weekend Edition, we're taking a break from our usual fare to share a recent piece from our colleague Greg Diamond, which was published for his Ten Stock Trader subscribers in April. In it, Greg details why "the trend is your friend"... and explains how key technical signals can help you ride the trend while it lasts.

Keith Campbell took a job in California so that he could both ski and surf.

Back in the 1960s, he relished the crisp mountain air and the majesty of coastal bays. So trading was probably the last thing on his mind.

But once he met a commodity broker named Chet Conrad, everything changed...

Conrad introduced Campbell to the world of investing, though he hadn't made any big trades. Eventually, the two decided to go into business together.

By the early 1970s, Campbell had scrounged $60,000 from 12 investors and sketched out a plan for what would become the oldest commodity fund still trading today – Campbell & Company. (It's also where I had my first trading job out of college.)

Campbell developed and applied a simple investing idea... "Everything we do we could do on the back of an envelope with a pencil."

Author Michael Covel discusses Campbell's trading approach in his book Trend Following, which profiles trend-savvy traders. Covel notes that Campbell's back-of-an-envelope approach was a "revelation to those imagine trend-following trading as overly complex."

The strategy seems easy enough... Just "follow the trend until the end." Now, trading the trend isn't always so simple. But the theme of trend following has turned out to be one of the most important factors for successful trading.

You need to focus on the trend within the setup you're tracking. If the trend is up, don't bet against it. If the trend is broken, reduce your risk and consider trading the new trend in motion.

So today, I'm sharing two examples of why sticking with the trend is so important... and how key technical signals can act as "clues" to keep us on track.

Bull market trends usually include a series of higher highs and higher lows... The higher lows tend to be corrections, while the higher highs mark the continuation of rallies.

The tricky part is figuring out when the market will correct within the trend and then resume its upward march.

But certain clues can signal when a correction could end and when a trend could resume...

While working at Campbell & Company, I traded the EURO STOXX 50 Index futures and the German DAX futures. I traded millions of dollars' worth of these markets every day.

Here's a recent chart of the EURO STOXX 50 Index, which includes 50 "blue chip" European stocks...

Overall, you can see the strong bull market trend... marked by the higher highs and the higher lows within the black dashed lines above.

So in April, when European blue chips began to fall, traders needed to look carefully to see when the bullish trend might resume...

I've marked the Elliott Wave count – a classic technical pattern – in blue numerals. This is a simple way of anticipating price moves based on investor psychology. Back in April, we were looking at a wave 4 correction within this bull market.

Without getting too deep in the weeds, prices often rise after moves like those.

Wave 4s can be tricky, still. That's why I tracked the possibility of an extended correction with a bounce and perhaps another drop into May. (I marked that scenario with black arcs at the bottom of the price chart.)

But one thing was clear. The wave pattern showed that the drop from the late-March high in the EURO STOXX 50 wasn't a crash-like scenario – the kind that "screams" a top and then marks the end of the bull market.

On the contrary, it fit well within the definition of a simple trending market.

Also note that the relative strength index ("RSI") within wave 4 is the same level that marked the bottom of wave 2.

Obviously, you can't write all of these details on the back of an envelope. But this chart shows that the trend was still intact and that a rally was about to unfold.

Now let's shift gears and look at a specific corner of the U.S. market...

The semiconductor sector is my favorite U.S. sector to trade. Here's a price chart of the VanEck Semiconductor Fund (SMH), which we use to track the sector...

Once again, we saw a strong bull market trend in April, with higher highs and higher lows. While the correction since March 8 broke below the black dashed line above, it entered support (marked with the red box)...

In trading, "support" means an investment isn't likely to break below a certain level in the short term.

To get there, the semiconductor sector sold off heavily in mid-April ahead of upcoming earnings reports. We can see that "oversold" level on the bottom of the chart in the RSI.

Oversold assets tend to rebound. Sure enough, since then, the semiconductor sector has climbed higher. And the recent volatility we've seen could offer a buying opportunity within the rally.

In general, no matter what's going on in the world, we have to keep investor fear and noisy headlines out of our technical analysis...

Whether we're following the U.S. semiconductor sector or the major European stock index, the message is the same – we need to follow the trend.

Good trading,

Greg Diamond, CMT

Editor's note: Greg has stepped forward with some of the most important warnings Stansberry Research has published in recent years. Now, he believes the market is headed for a major shake-up – and it could start as soon as next week...

But one "May Surprise" is filled with opportunity... if you prepare for it. Right now, Greg is sharing a strategy he has used repeatedly to book big, quick gains through any market environment... Click here to learn more.