Trading 101: The Trend
In the first part of our series we outlined that the purpose of technical analysis is to find trend changes as early as possible. As the price moves, our objective is to buy at a low price at the beginning of a bullish trend. Ride the trend upwards and sell at a higher price, as soon as we can identify a trend reversal—or to put it into fewer words: BUY LOW; SELL HIGH.
Sounds easy, right?
While “buy low, sell high” sounds as basic and simple as it gets, most will struggle to implement this simple principle in their trading process. There are a few typical issues traders encounter when trying to ride the trend.
They spot the trend too late—buying the hype, when the trend is effectively over.
They spot the trend reversal too late—losing all of the profits they could have made.
Calling the end of a trend too early—selling every retrace, missing the big picture.
You will rarely get to spot the exact beginning or the ending of a trend, although in hindsight, these setups will seem obvious. Trends exist over all timeframes, from several minutes to months or even years. Yet, all of them tend to have the same characteristics—a trend over several months will behave just the same as an hourly trend.
Trends, trends everywhere!
Which trends you hunt and, therefore, which timeframes you focus on should fit your style of trading. A ‘scalp trader’ will be interested in low timeframes – minutes to hours. The ‘swing trader’ will likely set his focus on hourly to daily charts. Meanwhile, a ‘position trader’ will take positions of weeks to months. Whatever your style is, it should reflect how much time you can devote to the markets.
The market is a time-consuming beast. If you’re employed, trading the lower timeframes will cost you too much time next to your job. If you’re unemployed, the higher timeframes will take too long for you to keep paying your bills. Before you get into trading and technical analysis, always perform a self-analysis of your possibilities and available resources.
How much time can you devote to the markets? Can you keep up with the rapid changes in smaller time frames?
What is your style of trading? Are you a swing trader? A position trader? More of an investor type?
Individual traders will have preferences that vary greatly. The techniques and methods to spot and analyze trend-behavior are the same on all timeframes. Yet, at the same time, the trends on the lower timeframes are always part of an overlaying trend on a higher timeframe. Always consider the high timeframe trend, no matter which timeframe you trade. It’s rarely worth it going against it.
Definition of Trends
Let’s get a bit technical. What exactly are those “trends” we want to utilize to make profits? Generally speaking, a trend is a prolonged period where the price takes one dominant direction.
An uptrend is the price going upwards for a prolonged period – the highs and the lows of each price swing are higher than the last one, respectively. Higher highs, higher lows. And vice versa, lower highs and lower lows signify a downtrend. Sometimes, the market will end up in an equilibrium of upwards and downwards momentum. That’s called ranging – the price ranges between the same highs and lows.
We can also categorize trends by their length and occurrence. In classical technical analysis, long-term trends are defined by months to years. Mid-term trends last weeks to months. Short term trends – days to weeks, and intraday trends are closed before the end of each trading day. However, the time-based categorization is arbitrary and will be used differently depending on who you talk to or which assets you’re talking about.
Trading trends rarely look as clean as in the illustration above. But overall, trends tend to move in waves, and every trend will include lower timeframe counter-trend movements.
Remember, short term trends are always a part of a longer-term overlaying trend. The uptrend movement you trade on the hourly chart could be just a small countermovement of the far larger downtrend on the daily. As a rule of thumb, the higher the timeframe, the more attention you should be paying to it. However, low timeframes have their uses too – they will help you get better entries, detect changes in the overlying trend quicker.
Therefore, traders should always analyze one magnitude higher and one magnitude lower next to their time frame of interest. For example, a trader focusing on the daily chart should always keep the weekly chart and the four-hour chart in mind.
The trend is the number one variable in technical analysis. It’s a crucial element in any trading. We desire to spot trends as early as possible, ride them for as long as they last, and recognize the end as soon as possible. Trendlines are one of the ways that will help you do that, and we will explain the fundamentals of them in the next article!