Trading the Trend
The Trend is a recurring market behaviour that doesn’t change. This makes it a very attractive characteristic of market behaviour to identify and trade. There is an endless stream of market commentators, analysts, experts and authors all writing about it, discussing its merits and talking about it. We are all trying to master what appears to be a very simple and common market ‘trait’.
The trend ‘trait’ is an important component of Stockradar’s Trend Intensity Indicator. It looks simple to buy near the start and sell when it ends. Unfortunately, we all live in the now and we don’t actually know what is ahead, how far the price will go, and for how long. It has perplexed and frustrated many market participants from the experienced to the budding trader. It looks easy enough, but it isn’t. Don’t we all know it and I’m sure you’ve all tried. There is one thing we do know, they occur, and they occur repetitively and probably more so than any other market behaviour. If we can’t master it, it can be great source of profits.
It realistically comes down to your development as a trader and the skills you develop. It’s not for everyone. But that’s not the point of the article as today I want to discuss with you the trend itself. I just want to make you aware of its great pull and its attributes as a trading tool, after all the trend is your friend. Also, to make you aware that really this is just another advantage we have over the market. You probably know what I’m going to say next? Yes, the only obstacle to you being a successful trend trader is yourself. As always, the argument comes back to your ability to observe, respond and trade. Your psychological power if you like. For another day.
Identification, like all market behaviours are recognisable patterns, it is as simple or hard as we want to make it. To be able to identify every trend in its beginning is impossible and even using a structured definition the market may not always play out as expected but we can develop an identification process that will identify most and give us an edge. Again, simplicity is of the essence. Too many rules complicate and confuse us and that makes it much harder to trade.
The simplest and most pure definition of a trend is, when prices move in an action of higher highs and higher lows and this defined as an uptrend. The reverse is true. A series or lower lows a lower highs defines a down trend in prices. From a realistic trading point of view the price action doesn’t simply go from one to another, there are periods when the market, or investors, need to adjust to a change.
Realistically there are three challenges we have when we trade a (potential) trend. Remember we don’t know that a trend is going to develop yet. So, what we are actually doing is identifying the potential for a trend to develop. So, firstly how can we identify a trend, secondly when should we get in, and thirdly when should we get out.
We now know what a trend is, that’s the simple bit, now we need to learn how to capitalise on it. In process of qualification I demonstrate how this process develops in the Trading Centre each week and show you some basic and simple techniques you can use that will throw you a template that you can use, develop and adapt to your own style. We all think differently and have our own styles. As with all trading processes, we make rules that says, if this happens, I do that, and if that happens, I do this. No argument.
A trend reversal is probably what you imagined it to be. It’s when the price action changes from down to up or from lower lows and highs to higher highs and lows (or up to down is the reverse). We know this doesn’t necessarily happen as an immediate thing it often takes time to develop. A stock or market, having had a trending phase, up or down, can go through a congestion phase that may or not be a ‘trend ending’ accumulation or distribution phase it may simply be a consolidation before it resumes its path higher or lower. What we need is robust definitions that defines an end or beginning of these phases and it must be good enough to capture the major portion of most trends.
The classical definition, and this is a robust one because it is very effective, is simply as follows. A series of higher highs and lows defines an uptrend and when a lower high is followed by a lower low the trend is considered to be broken or finished and we sell out. When a series of lower lows and highs that defines a down trend is followed by a higher low and then a higher high it defines the beginning of a new uptrend and we buy. This forms the basic initial input and underlying premise for the Trend Intensity Indicator.
Up Trend Broken
New Uptrend
Around this ‘perfect’ structure for a trend we need rules to control the trading aspect, because in fact they’re not always perfect, and in Stockradar terms the only time a trend is ended before the lower low lower high eventuates is if the stop loss risk parameter is hit before the trend reversal occurs.
This article is about trends and the application to the Trend Intensity Indicator not trading rules which are an extension of the Trend intensity indicator that make up my entire trading process. The trend in prices is the initial step and most important and heavily weighted aspect of the Trend Intensity Indicator. Prices are the raw data upon which other market studies are derived and is a great filter when trying to understand the supply /demand balance of a stock price.
Because trends occur all the time being able to identify and ‘ride’ them is a very attractive challenge for us all. As we know trends can take us many places and often, they will exceed our expectations. All we need to be able to do is ride them well enough to generate consistent profits and outweigh some of those losses we will incur. Price actions can be muddy sometimes so don’t expect them all to develop once a trend reversal has occurred but to capitalise on some of them is rewarding and satisfying and they can play a big part of trading plan returns.
