5.6 Trading with Trends - Trending Markets - Up, Up and Away

 

A trending market is like make a lightning fast attack across the field on the other goal rather than watching a crack team playing football and just passing the ball among them, back and forth.

 

The markets are like that, passing the ball and time when they are in ranging mode, but occasionally breaking out into a trend when the bulls or bears launch an assault on the other side. As a definition a trending market is one in which the price moves either upwards or downwards for an extended period of time. 

 

These trends, when price is moving in one direction, are great money-making opportunities. Of course, during the ‘assault’, there may be the occasional retracement, like a striking forward passing the ball back to his team-mate, but on the whole the ball moves in the direction of the opposite goal. Like this!

 

Forex trading with trends - A representation. 

 

No trend can keep the price moving in a straight line. There are always some moves in the opposite directions. These moves only represent a temporary correction and offer an opportunity to enter the market, to realize gains when the trend resumes.

 

We mentioned "extended period of time" and that calls for the question what period of time would justify the statement that price is trending?  Well, if you are in front of a 5 minute charts then what would you say if the chart appears as follows:

 

Downtrend on a shorter time-frame chart. 

 

The price has been falling for little over 6 hours and till the lowest point the total drop is approximately 80 pips. On the chart it surely looks like a downtrend but does such move qualifies to be called as a trend or in this example a downtrend? Let's seen the same move on a 4-hourly chart:

 

Different picture of the trend on longer-time frame chart. 

 

If we go higher on the time-frame, say daily or weekly chart, the picture may be completely off.

 

Let’s go back to the question that what time period would qualify a move as a trend?

 

Well, a real trend is which remains in place at least for several days, if not for several weeks or months or years. Yes, you heard that right. Some trends do remain in place for years too; here is an example of USD/CHF:

 

Forex chart  with multi-year downtrend. 

 

See how the currency pair had been in a strong downtrend from year 2002 to 2011. In fact during post 2011 phase it has been in sideways mode and that does not say that the trend is yet over and any reversal is in place.

 

So let's get back to our question that what qualifies as trend? Well, it is all relative and in a nut & shell the answer can be put in the following way:

 

  • If you are working with a monthly chart then a trend which remains in place for several years should be termed as a trend. The above USD/CHF multiyear chart is an example in which the several month's trends would only be considered as corrections or consolidations or retracements.

 

  • If you are on weekly charts then a trend which survives for several month can be taken as a trend.

 

  • On daily chart a trend would mean that the price action sticks with the direction for several weeks.

 

  • On a 4-hourly or hourly chart the trend should remain in place for several days to qualify as a trending market. 

 

Getting a trade early into a trend, and riding it till it reverses, is the holy- grail of Forex trading. So let’s look at how we can spot a trend early enough and reach our goal of pip wealth.

 

Steps for Trading with Trending Markets

 

Trading with trending markets involves the following steps:

 

  • Identifying trend

 

  • Identifying the long-term picture

 

  • Identifying the strength of the trend on longer-term time-frame as well as in the recent past

 

  • Identifying the possible entry points

 

  • Working out the stop-loss orders

 

Identifying trends

 

Identifying a trend has two different aspects about. It could be about identifying and confirming that a trend already exists or it could be about identifying the possibilities that an existing trend may be on the verge of reversal or that a sideways moving market may be changing to a trending situation.

 

The possibilities of the beginning of a new trend are indicated by various crossover methods. Some of the common indicators used to find this are; moving average crossovers (do check “Using Moving Averages for Trend Detection”), crossover of Tenkan line and Kijun line of Ichimoku cloud and MACD crossovers.

 

Identification of an existing trend is quite a simple issue. Just looking at a chart of various time-frames we can now whether the price is in an uptrend or downtrend or it is simply moving up and down in a range. What is important here is to analyze the longer-term trend and during those trend finding a correction which may be ending for the trend to resume. 

 

Identifying the Long-term Trend Situation

 

Your trading chart may be indicating a trend and you may be getting ready to jump in to make that trend your friend. However, it is always good to know as to how long that trend has been in picture. As we noted about that some trend can go on for years but then there are always trends within a trend. During any long-term trend there would be opposite trends which could also continues for a long time. Though you can have profitable trades while catching up these opposite trends but you can win big if you get into a trade when the current trend is in the direction of the overall trend. This way you can go for much bigger profit targets. Consider the following example:

 

Trends within a trend.

 

In the above chart the major corrections in the overall downtrend have been as follows:

 

  • Point A to B: The correction lasted for 3 months

 

  • Point C to D: The correction lasted for 11 months

 

  • Point C to F: The correction lasted for 7 months.

 

  • Point G to H: The correction lasted for 6 months.

 

As we see that if we are trading on a shorter time-frame chart, any of these corrections can be taken as trends as each lasted for several months. Any buying near points A, C, E or G would have turned out to be some great trades. However any short positions when the ongoing overall trend resumed i.e. near points B, D, F or H would have been like dreams comes true.

 

The essence is that look for the price zones where the ongoing trend may be resuming after a correction and go for a long-long drive.  

 

Corrections during a downtrend on a Forex chart.

Identifying the strength of the trend 

 

Identification of strength of the overall trend on a longer-term timeframe as well as current strength on the time-frame on which we are trading is critical to set the stop-loss orders as well as the profit targets. Stronger trends allow for wider profit targets and narrower stop-loss levels and hence better risk-reward rations. During weaker trend you may have to go for wider-stop loss levels and narrower profit targets. A trend which has started weakening also suggests the possibilities of a reversal or a deeper correction.

 

Some of the indicators which can be used to know the strength of the trends are as follows:

 

Using Average Directional Index

 

We hope you recall ADX from the indicator studies. The Average Directional Index (ADX) is a good indicator to use to test the strength of the current trend of the pair. It gives readings of 0-100 depending on the strength of the trend. A reading above 25 indicates a trending situation – the higher it reads, the stronger is the trend.  

 

Using Ichimoku Cloud

 

As we have seen that Ichimoku cloud is a great indicator for not only buying and selling signals but also for the trend identification and to know the strength of the trend. 

 

Gauging the strength of the trend by Ichimoku cloud. 

 

As a recap, a strong bearish trend is indicated if the price action is staying below the cloud and the price is continuously finding resistance near the Tenkan line. The opposite of this is a strong bullish trend when the price action is above the cloud and Tenkan like keeps acting as a support.

 

Using Moving Averages

 

Using multiple moving averages in a chart is a good way to identify trends. Normally during a range-bound period the moving averages tend to clump together. However when price starts trending up these averages tend to ‘fan’ or spread out. See the chart below.

 

Gauging trend strength by moving averages. 

 

We prefer 5-period EMA to judge the strength of the trend. See how the price has been continuously finding support near the 5-period EMA. This surely indicates a strong uptrend. On the other hand a strong bearish trend is indicated if the 5-period EMA keeps on acting as resistance. 

 

You will also observe that the price line was overlaid with the 5, 22 and 55 day EMAs. The first indication that the trend was moving to the upside came with the 5 period moving average crossover taking place first over 22-period EMA and then 55-day EMA. 

 

Subsequently, you can see how the EMAs ‘fanned’ out to the upside as the faster EMAs cross over the slower EMAs due to the increasing strength in the move and higher momentum. This shows that the higher current prices (short period EMAs) are prevailing over the longer term EMAs, indicating momentum on the buy side.

 

In a downtrend the reverse would be the case, with the short period EMAs crossing and fanning down below the longer term EMAs.

 

Fanning moving averages, therefore, are a good tool for assessing the trend. Please also that it is not necessary to use only exponential moving averages (EMA) but you can use other types of moving averages also.

 

Please note that the above tools are just some of the best ways to identify the trend strength and you can use some more technical indicators for the same purpose.

 

Identifying the possible entry points

 

Now once you know that you have a trend in place and the strength is good, you need to work on the entry points to place your trade.

 

The best entry zones would be the one when the price completes a correction during the trend and is about to resume the ongoing trend. Some of the tools used to identify the good entry points are as follows:

 

  • Dynamic resistance and supports levels by trend lines

 

 

 

 

 

 

If the trend is strong, it is always better to enter your limit orders above the expected support zones for buying and below the resistance zones for short-selling. 

 

Working out the stop-loss orders

 

Entering stop-loss order for each trade is one of the most important keys for success in trading. All the tools which are mentioned above to identify the trade entry points are also the tools to workout with your stop-loss entries. 

 

Unlike the entry points, the stop-loss levels would have to be below the expected support zones for long positions and above the resistance zones for short positions. 

 

 
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  • Trading with a Trending Market - up-up-and-away

 

 

 

 

  • Range or Trend, Volatility can be Your Friend as well as an Enemy

 

       

 

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