How to identify trends

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:

biker going up or down?
biker going up or down?
stairs up or down?
stairs up or down?

And a “hard” one:

up, down or ...?
up, down or …?

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…

GBPUSD trend
GBPUSD trend

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:

Lower lows and lower highs
Lower lows and lower highs

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:

Higher lows and higher highs
Higher lows and higher highs

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.

Examples:

median horizontal line
median horizontal line

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:

sideways
sideways

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.

12 thoughts on “How to identify trends

  1. Mike

    Look at the chart under the line:

    "Now let’s see how the opposite – higher highs and higher lows would look like, in an upward / bullish trend:"

    Zoom in and picture this same chart cut off at Feb 3. Visually, you are seeing a very week trend up to this point that appears to be going close to sideways. Thereafter it went up at a stronger angle. However, if I looked at this at Feb 3rd, my assumption would have been that it's about to run out of steam. Add to this the idea that trend only run for so long and by the time you see the trend, it could reverse at any time. There are other considerations as well.

    So, it's simple in theory, but difficult in practice.

    My question is whether Liviu really just pulls up any chart and says, "oho! there's an uptrend!", places and order and is now independently wealthy?

    Reply
  2. Liviu Post author

    Hi Mike

    I attached this chart cutting to Feb 3 here: http://bit.ly/cvdjoH

    The chart I used was a 4hrs one, so we look at an intra-day to short-term time frame (4hrs being highly significant in both time frames so we can use it as an interim one)

    What I see in the chart is that:

    - we were in a clear uptrend – higher highs & higher lows, rising trend line connecting the higher lows (other studies would confirm the uptrend too, although they were not added in the chart).

    - from the C high, price went down – hence intra-day (below 4hrs charts) most likely negative/bearish.

    - the break below the upward trend line could have confirm a reversal – if one would rely solely on trend lines.

    But what about Fib ratios? The possible scenario of dealing with a simple corrective move, therefore expecting the market to pick up either on the retracement/support levels of the last upward swing (B to C), eventually a larger correction (A to C). To be honest, in such cases I'd worry about trend's integrity only when retracement values would be violated, printing lower lows (such as below B).

    Or what about trading ranges? Would you call it a reversal due to 130 points down out of a 500 points uptrend range?

    It's simple in theory but difficult in practice and I highly agree. Could it be difficult in practice because it is our tendency to pick tops and bottoms? Such as thinking C is overbought and the market is going to collapse? Or by calling a reversal in a minor range of 100 points down in a 500-1000 points uptrend? It could be a self esteem booster to be right when picking trend reversals "to the pip", but I have yet to hear about someone doing it regularly. I'll follow him and pay for it.

    This chart example is not the best one to argue on how easily a trend could reverse at any time. There are better ones and I could just find some, if you like.

    To answer your question: my article is not about becoming independently wealthy by following a trend. It is about not using several different tools to tell you what you could actually notice with naked eyes. And the trend line I used in my chart is an example on how such tools would provide signals that might be false.

    p.s.:

    since we were using Feb 3 example and because everything makes sense on historical charts when looking back, I'll add some portion of my Feb 3'rd article on EURUSD which is inversely correlated to the USDCHF we are talking about – as a clear example of what was my interpretation at that time, when not being aware of what will follow:

    full article here: http://www.innerfx.com/analysis-and-forecasts/dai

    "The euro maintains its bid tone, recovering some lost ground against the dollar but still holds below the 1.40 handle. Resistance comes into the 1.4000-1.4030 region where the euro may face solid selling pressure"

    - EURUSD 1.4030 corresponding to USDCHF 1.0500 – so my expectation was for EURUSD to face solid resistance at that level, hence USDCHF facing support at 1.0500

    "in case of a rally out of the (potential) corrective range of 1.3850-1.4030"

    - whole move in EURUSD from 1.3850 to 1.4030, corresponding to 1.0630-1.0500 USDCHF was considered a potential corrective move.

    "upside seems favored but treat buying as walking on eggs, because selling may resume at any time"

    - I was aware of being in an intra-day uptrend cycle (downtrend in USDCHF) but noted that downtrend could resume at any time (uptrend in USDCHF, respectively) since it was most likely a correction (as said earlier), short-term momentum being bearish (bullish in USDCHF)

    My call was to sell EURUSD at 1.4030 (corresponding to buying USDCHF at 1.0500 – more or less few points). Check the chart, 1.0500 was the level where USDCHF found support, resuming uptrend.

    I don't talk about things I read in "get rich soon" books, I talk about things that work for me. If something else works for somebody else, such as mixing 7 fancy indicators to identify a trend – that's his own choice. It's a free world :-)

    enought writing, time for a beer now.

    Cheers!

    Reply
  3. Agoes

    Hi Liviu,

    Nice Thread…… I've been trading for a year and I lost much money, But anyway I like ur chart … .it's so simple

    I've got a question : Once you identify a trend, how do you enter the market ? how to get the best entry point ? and where to set the stop loss and profit target ?

    one more thing that I like from your trading style is : don't waste too much time on the chart ….. well, I waste so much time on the chart thats make me crazy :D

    wish that I can trade like you write ….. soon :p

    Reply
  4. Pingback: How to identify trends | Forex education by innerfx.com « TheRoninTrader Project 2.0

  5. Santosh tiwari

    I liked your trend articals & charts but one qu. Iwant ask how to identify false signal & strong trend going up or dowon how anlising with support & ressitance with chart plz. Tell me

    Reply
  6. Liviu Post author

    There's no specific method to identify a false signal. There are more but what they do are providing some clues, through filtering – if we talk about technical analysis here.

    What works better in my opinion is interpreting the market sentiment through fundamentals and if both tech. and fundamental point towards same direction – then it will be clearer that market turnarounds are corrective/ "false" reversal signals.

    The whole point in the article above was not what someone needs to use to identify a trend but what someone does NOT need (indicators) to accomplish a simple task like that.

    Filtering false signals can also be a matter of gut feeling and luck because you get to choose between "yes" and "no" …

    Reply
  7. Pingback: How do you identify a trend? | TTG Trading

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>