Welcome to the ultimate guide to trend trading first edition. Landing at this page is an opportunity for anyone interested in learning the fundamentals of professional trading. Whether you are a beginner and unsure of where to begin or experienced who needs to improve, I am confident that you will find value in this mini-course.
The information contained in this tutorial is the essence of decades of accumulated trading and technical analysis experience from several technical experts.
My ultimate goal was to create a complete all-in-one tutorial that aims to help you be a successful trader. From the basic concepts, through psychology, money
This first edition will include a part of the main fundamentals. It will be updated and expanded with time to reach my ultimate goal as an all-in-one complete trading course.
Concepts and Foundation
If you hit the google search looking for the term “Trend”, one of the first results should be “A general direction in which something is developing or changing”. The trend is a dominant bias in any aspect of life.
For example, we could say that the trend for classic 19th-century men caps is strongly dominant these days. And that basically means that a lot of demand is going on for 19th-century men caps that make them a theme these days, weeks or months.
Demand is always the main driver for any product. Price and supply are the other parts of the equation. The interaction between the three is constantly changing and make-up the market.
In the financial markets (Whether in Forex, Stocks, or any other asset class), any financial instrument price is driven by demand and supply. The instrument is said to be in an uptrend when there is enough demand to make it move higher for a period of time.
What creates those trends is some major underlying fundamental and economic factors. Major factors like monetary policy outlook can impact securities persistently for a period of time, creating long term trends.
Technical analysis is not concerned with the factors behind a trend, or the reasons behind the change in the prices of the instrument under analysis.
The reasons behind the price movement can vary widely, from political, economical, investors expectations and emotions, and many more. In most cases, these factors, and their interpretation can’t be accurately expected or gauged.
Technical analysis is concerned with the price itself as it reflects all these factors(price discounts everything) and therefore no additional information is necessary.
Studying the price movement for decades, practitioners observed a repetitive behavior that is dominant across all asset classes. The main cornerstone for technical analysis is based on this one main idea of trends.
The most basic and fundamental assumption that technical analysis relies on is that the prices -of freely traded securities that have sufficient trading volume -move in trends and trends tend to continue rather than reverse.
Technical analysis is the art of identifying a trend at an early stage and maintain a trade position until evidence indicate that the trend has reversed.
Simply stated, a trend is a directional movement of the price that can be to the upside, downside, or just horizontally(Sideways).
The directional trend is a dominant motion in one direction that is interrupted by smaller moves in the opposite direction, these opposite moves are called corrections or pullbacks.
In many instances, a trend can be spotted by bare eyes. However, for professional technicians, it’s not just about the general directional move. The practitioner needs to be more specific as trading requires exact entry and exit points. let’s discuss the structures for each trend type.
An uptrend in its general definition is a directional move to the upside that can be spotted visually. Technically, an uptrend should have a distinctive structure of consecutive waves, where each wave surpasses the prior wave.
An uptrend is a series of higher highs(peaks) and higher lows(troughs). Where each high surpasses the previous high, and each low is above or equal to the prior low. Each major upside wave is followed by a downside correction.
A Downtrend is the exact opposite of an uptrend, it is a series of lower highs and lower lows. Where each low surpasses the previous low and each high is lower or equal to the prior high.
Before moving to a real-life example, we need to explain two more key concepts, support & resistance and breakouts.
Support & Resistance
The troughs and peaks that the price establishes -while trending-are support and resistance levels.
These levels are extremely important as they reflect a change of equilibrium between supply and demand. Indicating a shift of psychology from a selling interest to buying interest or buying interest to selling interest.
Support and resistance determine when trends have reversed in the past and are a clue as to when they will reverse in the future
For instance, if supply is higher than demand, the price of an instrument falls. As the price reaches a support level below, demand increases again to exceed supply forcing the price to reverse direction and move higher.
The opposite is true for resistance. If the price was rising due to higher demand, the area at which the price reverses to the downside reflects a change from higher demand to higher supply and thus the price reverses direction, making this level as resistance.
Support and resistance are levels where the price tends to stop and reverse direction. Resistance is a level above the price, where supply gets strong enough to exceed demand, forcing the price to move back lower.
Oppositely, Support is a level below the price. where demand gets strong enough to exceed supply, Forcing the price to move back higher.
Resistance usually turns to support when a breakout completes as illustrated in the chart below. The opposite is true when a breakout below support materializes, support usually turns into resistance. This is a very important phenomenon.
Support and Resistance Zones
When the price forms multiple highs or lows near but not at the exact level then the whole area should be marked support or resistance, and it is called a support or resistance zone.
A picture is worth a thousand words. Here is an example:
What is a Breakout?
A breakout is simply a move beyond a price level, typically support or resistance. A breakout usually signals a major move ahead or a change of a trend.
Many technicians have their own methodology in identifying a valid breakout. For some traders, a breakout above or below a level is merely the price ability to trade above or below that level. For example, if a trader identifies 1.3000 as an important level for the EURUSD, and the price trades just above that level at 1.3001, he/she might consider this a valid breakout! Although this approach might be valid for some, it’s not optimal.
The Closing Method
Many technicians use the closing technique to confirm a valid breakout. Simply stated, the price must close above or below a specific level on the time interval being analyzed to confirm a valid breakout. And I personally prefer this method. For a breakout to be valid there should be a CLEAR closing above or below the level for the time interval being analyzed.
The Percentage Method
Another method traders use is based on the price ability to move minimum percentage points beyond a certain level. An arbitrary number of 1 or 2 percent is common. However, it’s is more efficient to decide on this percentage based on the nature of the underlying instrument under analysis. For example, some instruments are more volatile than others and may require a wider filter of 3 percent.
A false breakout is simply when the price of an instrument successfully breaks below/above support or resistance but fails to maintain the move for a sufficient distance, and the moves back in the opposite direction.
Directional Trend Example
Here is a real-life example of a Downtrend on NYMEX Crude Oil Daily Chart. This example is intended to help you identify the downtrend correctly(Same procedure goes for an uptrend). It might look confusing at first sight, however, if you start reading the chart from the left-hand side and move with the price action it should make sense in no time.
If you start from the left-hand side of the chart and move forward with the price action, you will notice the clear structure of lower highs and lower lows(Downtrend). Which was maintained for the whole period we examined. Note that in mid-October, there was a move higher beyond the prior swing high. However, for us, that wasn’t a valid breakout as the price has marginally closed above the previous high and therefore the structure of the downtrend(lower highs and lower lows) was still intact. As we mentioned earlier, for the breakout to be valid, it should be clear and noticeable. If it doesn’t scream a breakout, do not take it.
When the price movement go undefined, where a technician can’t spot any series of uniform higher highs and higher lows(uptrend). Or lower highs and lower lows(downtrend). Then it is a sideways trend.
When the highs and lows are mixed without a clear sequence, and they appear roughly near the same level, that would result in a horizontal movement and a shape that looks similar to a rectangle. In that case, the market is said to be sideways, flat, ranging, or trend-less. All names have the same meaning.
Here is an illustration of a sideways trend.
In the NYMEX Crude Oil example above, there was a period where the price entered a sideways trend. It was a part of the overall downtrend. Zooming into this period between September and early November we can extract the following sideways trend example:
A breakout of the sideways range in any direction usually signals a trading opportunity and a change in the trend.
Trends are Fractal
A fractal is a repetitive pattern. Fractals are infinite patterns that are self-similar across different scales.
Trends of different lengths tend to have the same characteristics. In other words, a trend in annual data will behave the same as a trend in five-minute data.
As a trader or investor, you must choose which trend is most important for you based on objectives and personal preferences, and the amount of time you can devote to watching
The chart above is a clear illustration of the fractal nature of trends. You can see multiple short term trends within one longer-term trend. If you zoom further into the price action, you will find inside these short term trends shorter trends and so on.
Long term trends are more reliable than short term ones. This is a general rule of thumb in technical analysis. The shorter the time interval the more unexpected and noisy it is. Why?
As I mentioned earlier in this tutorial, major and dominant demand trends are a result of major fundamental factors, these factors are usually persistent. While, in the short term, the price can be affected by any temporary factors, such as misinterpretation of data, irrational exuberance or false news.
Fact: Although the trend concept is easy to understand, its application is difficult and tricky. Determining when that larger trend is reversing is a tough decision because the price oscillates back and forth in smaller trends along its travel in the larger trend so any signs of reversal may only be for smaller trends(corrections) within the larger trend.
Tip: Many technicians observed that an actual trend lasts only a short time -less than 30 percent of the trading period-and during the remaining time, prices remain in an indefinite trend or sideways trends. While there is no study of the accuracy of this percentage, the main idea to keep in mind is that as a trader you should anticipate periods of sideways movement more than anticipating a uniform up or downtrends.
Trend Identification and Reversals
There are multiple methods or techniques to identify or spot a trend. The most popular methods
We have just explained in the previous part this method of identifying trends using the peaks/troughs. This is the most important and widely used method. We mentioned that the trough and peaks are potential support and resistance levels. So what if the structure breaks?
A key warning the trend could be reversing or stalling is a breakout below the latest trough in an uptrend. Or latest peak in a downtrend.
While this break doesn’t guarantee a trend reversal(just like any other technical development), it is an important development that should be considered in your decision-making process.
Breaking the latest trough in an uptrend or peak in a downtrend is important by definition, as this break will invalidate the uptrend or downtrend structure. Thus, the price no longer has the structure of higher highs and higher lows and therefore the trend could be reversing.
Here is an example of a clear downtrend structure that was violated by breaking the latest high.
Another widely used tool to define a trend is a trend line. A rising or ascending trend line is constructed by connecting the first two higher lows in an uptrend and extending the line into the future.
You need at least two higher lows to connect a rising trend line and extend it as shown on the chart above. The trend line usually acts as a support for the price, as obvious in the third and fourth touch in the above chart.
The opposite goes for a falling trend line. We need at least two lower highs to connect, and the trend line should be treated a resistance.
Trend lines represent the slope of the move or the slope of supply and demand. If for instance, the trend line is very steep, that indicates a strong overwhelming demand compared to supply.
Tip: The steeper the trend line the less reliable it is. And it will most likely be broken quickly. As sharp moves are usually indicative of excessive emotions and in most cases not sustainable.
Tip: The longer the trend line and the more times that the trend line is touched by prices, the more significant it is, and the more significant the reversal when the trend line is finally broken.
A break of a trend line is merely a warning signal, it doesn’t conclude a trend reversal, but warns of a possible one.
As we mentioned earlier, the trend line represents the slope of supply and demand, an, therefore, a break of it is indicative of a change in the supply/demand trend.
The breakout of a trend line is one tool that should be used alongside other technical tools and within a broad trading strategy.
Adjusting Trend Lines With The Price Action
Usually, the price penetrates a trend line during the trading session of the time interval under analysis. But never closes the session below or above the trend line, where it’s rising or falling trend line.
These intra-day breakouts should be ignored, and the trend line should be adjusted to this newly recorded low.
Also, the trend line should be adjusted following minor false breakouts.
Accelerating and Decelerating Trend lines
A repetitive phenomenon in the markets is the price acceleration and deceleration. It is very common that you see the price trend start slowly and suddenly accelerates and the upward wave gets sharper and steeper, especially in times of speculative bubbles.
The chart above illustrates this phenomenon, where U.S. Crude Oil futures started a healthy uniform uptrend in early 2017, before starting to accelerate early 2008. A rising trend line can be drawn for each acceleration. Where a break below the steeper trend line signals a move to the next less steep trend line.
The above chart is an example of decelerating trend lines. This phenomenon is the opposite of the acceleating one. Whre the price decelerates breaking a rising trend line but not resulting in any noticable reversal, and moves back higher. A new trend line is then drawn to account for the new trough or peak.
Tip: In theory, the price could repeat this pattern endlessly, but practitioners have concluded that three decelerating lines are the maximum that can be expected before a real sustained reversal.
A channel looks like a rising or falling tube that carries the price motion. It is constructed with two parallel trend lines.
In an ascending channel, two rising trend lines form the channel. The first rising trend line is the main trend line that connects the higher lows, which is the support line. The other trend line is an exact parallel for the first one, plotted starting from the first peak in the trend and projected to the future, and it is the resistance or supply line.
Channels usually contain most of the price action.
In ascending channel the price tends to find demand near the bottom of the channel, while supply increases near the top of
A falling or descending channel is constructed by parallel falling trend line. The upper falling trend line is considered a resistance, while the lower falling trend line is support.
A breakout above the falling or descending channel is similar to breaking a trend line. The outcome is a warning of an upward movement or a trend change.
Tip: Sometimes the price breaks in the direction of the channel. For instance, the price breaks above the rising trend line for the ascending channel. And that could be interpreted as an acceleration of the upward move as new demand is entering the markets. However, false breakouts are also common, where if the price failed to sustain trading above the channel and moves back within the channel, it is an indication that it might be just a false breakout and the supply/demand slope is back to the prior stage.
Always keep in mind that technical analysis is more of an art than sciences. Don’t be very specific or look for perfection, you will rarely find it. The market may not react exactly at the trend lines every time. Sometimes prices may move a bit higher or lower on an intra-day basis but close on or near the lines.
Moving averages are one of the most popular and reliable tools in technical analysis. Simply a moving average is an average of the -closing- price in the past X periods. It’s calculated each new period and plotted on the chart. The result is a smooth continuous line that represents the price average for that past X period.
A Moving average smooths the erratic price action, and lessen the effect of short term fluctuations. And that helps the analyst focus on the main underlying movement or trend.
Moving averages can be calculated in several methods, the most important and common are the simple and exponential moving averages.
Simple Moving Average (SMA)
The most basic and popular is the simple moving average. And is calculated by a simple arithmetic mean equation.
SMA(n) = Pr1+Pr2+……..+Pr(n) / n
n: Number of periods Pr: Price(usually closing price)
To calculate the 10 days moving average,
SMA(10)= Pr(1)+Pr(2)+…..+Pr(10) / 10
Exponential Moving Average (EMA)
Another popular type is the exponential moving average. The exponential moving average equation gives more weight to the recent data. And that makes it more responsive to the recent price changes. It is said to be faster than the simple moving average.
How To Use Moving Averages
Using the 10 days moving average is simply like having the general direction for the past group of 10 days.
Having that in mind, choosing a short period will represent the short term trend. While using a longer period, i.e 200 days will give a longer-term view. In that manner, you can focus on the trend that fits the time horizon of your interest.
Moving average are better used on the longer term time intervals. The most common and key moving average periods are:
- 200,100,50,20,10 days
- 52 and 200 weeks
- 12 month
For the short time horizon, the 10,20 and 50 days moving averages are the most useful. While for longer time horizons, the 200 days and 52 weeks are the very reliable.
Moving averages provide the analyst with important information:
- Identify the underlying short, medium and long term trend.
- Two moving averages crossover(one short and one long) is considered a trading signal in mechanical systems or a trend change.
- A moving average often acts as support and resistance.
- Moving averages crossover or intersection level is a support or resistance.
- By comparing the distance between the price and the moving average, you can gauge price extremes. Because moving averages represent the mean, if the current price has deviated substantially from that moving average, the price has a tendency to return to it.
- The price cross of a moving average is considered a signal.
Tip: The longer the time period of the moving average the most reliable and important support and resistance it is.
Warning: Be confident that a directional trend exists before using a multiple moving average cross over signal. As these crossovers will result in many whipsaws if the price is trading sideways.
In the next editions…
- More key trading tools
- Multiple time-frame analysis
- Having the right mindset(Psychology)
- Money management
- Putting all things together… Apply
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