When it comes to the basics in trading, it is a common thing but also time consuming (and quite irrational) to use a lot of indicators, even advanced ones, to identify something so simple that even some 5 years-old child would recognize with the naked eye, without using a state-of-the-art charting platform. I am surprised how many traders face difficulties, on a regular basis, when identifying trends. One of the reasons for the failure on identifying market trends is using various technical tools which react in different ways to price action, either causing confusion or signaling trend changes too often due to spikes, retracements, tight consolidation cycles, gaps etc – hence not seeing the forest for the trees.
This short article aims to support once again the “keep it simple” principle and the fact that you do not need a complex solution to answer a simple question. A simple solution is less time consuming, therefore allowing you to allocate your time other activities.
The question that always comes in my mind is why would someone use a lot of technical studies to identify something clearly visible?
Do we need a light meter to know if it’s day outside? – nope.
Do we need to calculate gravity before throwing a rock off a building? – No. We know it will fall fast …and someone might get hurt.
Do we know where the left direction is? Or the right? Sure we do.
The meaning of relative direction words is conveyed through tradition, education, and direct reference. So we all know where left or right is, therefore we most likely know where up or down is, too.
Let’s define trend – trend is the course / tendency or direction of the financial market.
Repeat: direction. Again: DIRECTION.
What’s the direction a market goes? -It is up, down or sideways / neutral – from left to right (the time axis) on a chart.
Coming back to what I mentioned earlier – that you don’t have to be an experienced trader, nor have an MBA degree, to identify which direction an object moves. It is common sense.
And some exercise:
And a “hard” one:
I’m sure it was easy to identify direction in the pictures above. Would it be harder to identify it in charts? let’s see…
Do we need any indicators to know that the trend in the GBPUSD chart is down? Obviously not.
An upward trend, or bullish, is also defined by series of higher highs and higher lows. The opposite applies to the downward trend, or bearish, which is defined by a series of lower highs and lower lows. Using the same GBPUSD chart, we draw the lower highs and lower lows:
I used L for lows and H for highs. Notice how fresh lows and fresh highs are formed lower in a downtrend.
Now let’s see how the opposite – higher highs and higher lows would look like, in an upward / bullish trend:
What do we have in the picture above? Series of higher highs and higher lows. The same principle applying to stairs: when ascending stairs, each new stair is a higher high and higher low formation (lower lows and lower highs when descending stairs).
Do we need trend lines and other technical tools to identify a trend? Definitely not. We don’t even have to add notes on the charts where higher highs/lows or lower highs/lows are formed. Practice makes it possible to recognize such levels and memorize them, without using any tools.
One technique to identify trends is to draw an imaginary horizontal line in the middle of the chart. If the chart starts from lower half and ends in the upper half – trend is bullish. The opposite for bearish: chart starting from upper half, ending in lower half – trend is bearish.
But what about sideways? In case it starts around the horizontal line dividing the chart and ends around the same line and vertical deviation from the horizontal line was negligible – trend is sideways.
When moving sideways, the market does not form series of higher highs/lows or lower highs/lows – but orbits around the same level, such as this (median) horizontal line:
Before identifying a trend, it’s very important to decide which time frame to choose and set the chart’s time frame accordingly. Therefore, if we plan to identify the intra-day trend – we will look at intra-day charts (minutes to hours), not at the weekly or monthly ones. If we want to identify a long-term trend, the chart should contain the market moves since months and years ago. In a future article I will discuss about time frames since it is a very subjective topic and different people define short-term, medium term, intra-day etc in different ways. For instance, if trader Joe defines short-term being a time frame of 48 hours to several days, some folks would argue, defining “their own short-term” as being 2 hours to 1 day or 5 minutes to 12 hours and etc.
If you still prefer to use technical tools to identify trends, using Moving Averages or trend-lines should be enough. Moving Average lines will move along with the market trend, lagging more or less depending on the MA period setting. So if a moving average is rising – trend is upward; if the moving average is falling – trend is downward. For some people It could be easier to identify if a line is rising/falling instead of identifying if the market is rising/falling. Moving average lines applied to Low or High (instead of traditionally applying to Close) prices would help determining the lows and highs while you’re looking after lower lows/highs and higher lows/highs.
Trend lines are used to connect lower lows/highs or higher lows/highs. Is it really needed to draw a line and connect lower lows/highs to know that lower lows/highs are being formed? Not really. Both trend lines and Moving Averages are a lot more useful for other purpose such as identifying support/resistance zones and trading ranges but these are different topics.
Another important topic is the trend strength, which I will discuss in a future article. What I can tell now is that for measuring trends’ strength I prefer the angles – smaller angles: weaker trends, larger angles: stronger trends. Average duration of pullbacks (how fast price resumes trend on corrections) is another key and measurable thing when identifying the trend strength.
Should you have any questions, please ask. Comments are welcome.