October 6, 2015 at 4:59 pm
I have come to realize that most traders struggle with trading because of one huge mistake they make. When I ask them to show me their trades that they lost, I can see that most of them are counter trend trades. Taking trades against the trend is a recipe for disaster. I would only recommend counter trend trading if you are an advanced trader. I am sure most of you have heard the saying “the trend is your friend”. This statement is totally true, but the trend is only your friend if you know how to identify it correctly. Identifying a trend might seem simple, but it can be tricky sometimes, especially if you are new to technical analysis.
A trend in the financial markets is the direction in which the market moves over a period of time. Trends can be categorized as secular for long time frames, primary for medium time frames, and secondary for short time frames. Traders can identify in which market environment they are trading by making use of technical analysis.
Newton’s First Law of Physics details that, “An object in motion stays in motion with the same speed and in the same direction unless acted upon by an unbalanced force.” This statement also applies to the trends in financial markets. Trends have a natural bias to continue in the same direction, which is why you should concentrate on trading with the momentum of the trend.
It’s always easy to identify a trend in hindsight. Normally when you see a trend that has been going on for a while, the chances are that it will reverse soon. The reason for this is that many traders see the trend once it is obvious and want to capitalize on it. Banks and hedge funds know this. They use this knowledge to their advantage so that they can fill their huge orders. The trick comes in to identify the trend when it starts. This way you can make your trades before the other traders even spot the trend.
Markets are always in an uptrend, downtrend, or it will be ranging (sideways/horizontal market).
It is important to remember that there could be more than one trend present at a time. For example, the EUR/USD weekly timeframe could be in an uptrend, but the 4-hour chart could show a downtrend. The best way to overcome this type of confusion would be to use a large timeframe for the general direction of the market and a smaller timeframe to trade from. Only take trades once the smaller trend is in the same direction as the larger timeframe’s trend. For instance, we see that the 1-hour trend is up, so we wait until the 5-minute trend changes to an uptrend to take call trades. You will significantly increase your chances of success by doing this.
There are multiple ways that you can identify a trend. You should stick to a method that works for you. Let me give you a few examples of how you could identify whether you are in an up- or downtrend.
Spotting the highs and lows are by far the most common way to spot a trend on a chart. Higher highs and higher lows show an uptrend while lower highs and lower lows indicate a downtrend.
Figure 1 – Highs and Lows
The second way to determine whether the market is in an up- or downtrend is through trend lines. When the market is in an uptrend, you would want to connect the higher lows with a trendline as demonstrated in figure 2 below.
Figure 2 – Uptrend Line
When the market is in a downtrend, you should be able to connect the lower highs that prices are making with a trendline.
Figure 3 – Downtrend Line
If you are unsure how to draw these trend lines, take a look at our Trend Lines Strategy Article. We show you how to draw trend lines and we also give you a free indicator that will automatically paint them for you if you struggle.
Some people prefer to spot a trend using moving averages as a guide. The most common parameters used in identifying trends are the 10- and 30-period moving average. When the 10-period moving average (red line) is above the 30-period moving average (green line) it is believed that the asset is in an uptrend.
Figure 4 – Moving Averages Shows Uptrend
In a downtrend, the 10-period moving average will be under the 30-period moving average.
Figure – Moving Averages Shows Downtrend
In this Part 1 we discussed what type of trends there are and how to identify them. In Part 2 we will look at how you can spot the end of a trend or maybe a potential trend reversal. Make sure you check it out.
October 8, 2015 at 7:30 am
Very, very good article. I think once you know how to identify a trend, you are already more than halfway to being a successful trader.
October 8, 2015 at 8:54 am
Hey thank you for the article.
I have a question though… When you are identifying a trend with moving averages, does it have to be the 10 and 30 period moving averages?
October 8, 2015 at 9:34 am
Welcome to the forum btw 😉
Excellent questions that I am sure a lot of people would also like to know the answer. In the example, Alex used the 10 & 30 moving averages. Why? Because traders most use it to identify a trend. There is no right or wrong here. Depending on the time frame one can even use the 200 EMA (Exponential Moving Average) to identify a trend. So coming back to your question – No. There are many different combinations of moving averages or even single moving averages that top class traders use to identify the overall direction of a trend.
All the best,
October 8, 2015 at 12:02 pm
Following the highs and lows that prices print is definitely the best way for me to identify a trend. I find that when you are able to draw a trend line, the trend is almost at its end already.
October 9, 2015 at 3:06 pm
I have a trick I learned along the way to identify highs and lows easier. All you have to do is to insert the ZigZag indicator on your chart. This will show you most of the swing highs and lows on the chart. I have since taken it off my chart, but it sure helped me get used to spotting these points on the chart.
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