The trend is your friend. We’ve been investing and trading for over 20 years and this old saying is fundamental to our success.
Go against the trend then you massively increase risk which means you need larger stops and targets which are much further away from your entry point. Some traders (and subscription services) even purport “NO STOP” strategies which are immensely risky! Use these at your own peril!
So how do you know what the trend is – and what TIME frame(s) should you be looking at? Both very good questions which need answered.
What is a trend
A trend is simply a direction and there are 3:
- Up
- Down
- Sideways
Simple – we don’t even need to find a graphic for that.
But, trends don’t move in a straight line – they “cycle” like this:
Upwards trends
The chart above shows the S&P 500 (SPX Index) as a candlestick chart from April 2021 to September 2021. You can quite clearly see that the underlying trend is up but you can also see that the market cycles. In this period the market had 4 cycles but was trending upwards throughout. If you are trading a market it is imperative you understand this. Don’t become fixated on a view. Look at what the market is telling you.
Downwards Trends
The chart above shows the GBP USD currency pair. We are closely watching this pair and our followers will note that we had a short entry identified for around the 21st October. This trade worked very well because of our understanding of the trend and the cycle. There was no guarantee the market would fall at this point but the underlying dynamics of other markets and the established pattern made it a high probability. Will this trend continue? We don’t know but we will be watching the completion of the current cycle very carefully for clues.
Sideways Trends
A sideways trend develops when supply and demand being to equate to each other which results in the average price across a period of TIME or cycle being flat.
Sideways trends can signal potential trend changes but more often than not the relevant market may just be consolidating it’s position for a short period of time. We don’t get too hung up on sideways trends as most of our markets establish a direction one way or the other.
Sideways trends are generally seen in small time frames (which we don’t trade) and we don’t have an example we would happily class as a true short to medium term sideways trend. It’s most likely a slow down of trend then change in trend.
How to Identify a Potential Trend Change
The “Holy Grail Question”. No one knows when the underlying trend will change and anyone who says they do are deluded – or offering “Snake oil” paid services. You only KNOW after the event. However there are many methods you can use to establish when and at what level a trend might change. Note “WHEN” is very important and often overlooked by many traders who become fixated on levels and their view as to where a market “should be going”.
Here a the top things we look out for in identifying a POTENTIAL trend change.
- Impact of different TIME periods – e.g. short term upwards trend within a long term downwards trend market.
- The amount of TIME the market spends above and below trend and whether this is changing over TIME.
- Unexpected changes in levels and timings of current cycle – e.g. stopped out on a cycle trade.
- Trends and cycles in other markets – e.g. swings in GBP USD may impact FTSE.
That’s pretty much it – yes we do keep an eye on “stuff going on” and yes we adapt when the world “melts down” but those are events no one can predict. They are simply a signal to check your underlying strategy and establish whether anything has changed.
We hope you like this article – send us a note if you do on Twitter or Facebook. We hope do do some more articles in the coming weeks helping you to mitigate risk on your trades.
In the meantime don’t buy into any “snake oil” sales people and control your risk!