How to Map Trends

There is a saying among traders that “the trend is your friend”. This certainly expresses the importance of a good trend and why fading ones are proving to be a big mistake for the vast majority of traders.

The technical analysis side of forex trading is all about the recognition of trends and patterns, in order to forecast the direction of an instrument’s next movement. In order to do this, an investor may approach the task from various angles, using one or more tools to read and trade on prices.

When learning to identify a trend, an amateur trader should start by looking for one of three things: movement up, down or sideways. These market phases play out across a chart that has been set up to display a particular scope of time, in a trader’s preferred format.

Line graphs are considered the most simple approach, removing much of the finer details and leaving a clearer picture. From this, any highs, lows and the general direction can be easily determined.

Upon this line graph (or even another style of chart), more advanced trading tools may be used to determine patterns and map trends with greater accuracy. Moving averages, channels and trendlines may be applied to identify range, and there are numerous indicators in existence to assist with the recognition of strength too.

How to Spot a Trend

It goes without saying that the bigger the time frame, the more important the move. A trend on the five minutes chart has less significance than one on the daily, or the even larger time frames. Therefore, identifying and trading a key trend on a larger scale is something that all budding traders are eager to do.

When it comes to technical analysis, the very definition of a ‘trend’ is recognized through a series of lower highs and lower lows (in a bearish trend) or higher lows and higher highs (in a bullish trend). To be more precise, let’s assume that according to our market perception or analysis, price is supposed to turn from a specific area and start a new trend. The first thing one needs to do is to look for a bottom (if the new trend to start is a bullish one) or a top (if the new trend is bearish) and then a spike higher or lower, depending on the trend.

To recognise if a bearish trend is about to start, the previous higher low spike must be located as a starting point. Following this, the new higher low spike breaks the previous bullish trend, resulting in a retracement or consolidation. Providing the top is not broken, the next step is to draw a horizontal trend line from the end of the lowest high spike – as shown in the example chart below.

Should this be analyzed correctly and if all the conditions are met, by the time the horizontal trend line is broken to the downside, we can assume a new, bearish trend has begun. You should then look for the series of lower lows and lower highs to continue from this moment on.

In order to locate the areas to sell (in a bearish trend we want to sell into spikes or resistance areas), you will want to make the trend even more visible. A trend line can be drawn connecting the start of the trend with the highs in the first spike higher. From here, dragging the line on the right side of the chart should offer more visibility regarding future resistance.

The opposite is true when trying to spot a bullish trend, except that buying, rather than selling is involved.

Trendlines

Trendlines are drawn to showcase the highs and lows of an instrument, helping you to decipher the direction and speed of a price.

Drawing a trendline might look simple, but it requires clear set of rules to be successfully used when trading. As such, many traders do not appreciate the full potential of such a tool, drawing the line incorrectly.

To begin, a trendline may be drawn only if a series of lower lows / lower highs appear, or even a series of higher lows / higher highs. When trending lower, the line is falling and as such we should look to trade on the short side with forex markets, or put options when trading binary. The opposite is the case for trending higher, with trade on the long side for forex, or call options for binary. Overall, the bigger the time frame, the stronger the support and resistance, and the more sizable the positioning should be as well.

Secondly, a trendline has many applications when it is used within trading a pattern. For example, in a head and shoulders pattern (example shown below), the neckline is the most important aspect – showing both support and resistance on the right shoulder, based on information contained on the left shoulder, as well as providing the measured move.

After it is broken, a trendline is usually retested, transitioning a support level to a resistance one and vice versa.

When trading in wedges, the 2-4 trendline (Elliott Waves Theory) is the most important one and therefore the application of a trendline in this scenario is very successful. By the time the line is broken, the wedge is considered to be complete. Should the wedge had been rising at this point, a trader could look to go short or trade put options, and if the wedge had been falling then call options or long positions could be traded.

Last but not least, we must consider the most important trading pattern of them all: triangles. Markets spend most of the time in consolidation areas and these are predominantly triangles. A triangle travels between the a-c and the b-d trendlines. By the time the b-d trendline is broken, the triangle can be considered complete and a new move may now begin. See below chart for an example of this.

In short, a trendline may look simple but its potential may only be reached with exacting rules and an astute application of technical analysis.

The 4 Types of Forex Trader

What, why and how you choose to analyse a particular instrument is usually down to your personal trading style and ambition. If trading represents taking the decision to buy or sell specific financial instruments, based off variations of fundamental and/or technical analysis, then from this classification, there is further differentiation between traders, who are categorized based on their chosen method of analysing the markets.

• • Scalpers – Traders that are looking to profit from short, to very short-term market movements are referred to as scalpers. Many of them rely on technical analysis in the form of a trading system, based on indicators (mostly oscillators). The time frames used in this scenario are the smaller ones, such as five, or even one minute increments.
  • Day Traders – Day traders tend to map out their strategy at the start of the day, choosing a position and finishing their day in a more or less profitable position. Their style doesn’t call for holding overnight positions. These traders are still looking to leverage large amounts of leverage in order to take advantage of small price movements for profit (usually forex, highly liquid stocks or indices).
  • Swing Traders – Many traders look to the market for medium to long term prospects, varying their trade duration anywhere from a couple of hours, to even one or two months. These are aptly named swing traders, and are known to have admirable patience when the markets consolidate – a quality many should like to emulate in order to avoid the pitfalls of overtrading.

Swing traders focus the majority of their investments within the bigger time frames, such as daily, weekly and monthly charts. In order to see these trading initiatives come to fruition, swing traders want to try to catch a bigger trend market start. A concrete strategy for this is to identify a trend on a chart, before adding it to a position on any pullback, with the idea that the trend is still strong.

Such trends can be identified in various ways. For example, a channel could be drawn on a chart with the purpose of selling the upper side for the lower one (in the case of a bearish trend), or buying on the lower side of the channel for the upper one (in the case of a bullish trend).

Other strategies involve the use of trend indicators, such as Bollinger Bands or moving averages, applied directly to the chart. When using the Bollinger Band indicator, a strong trend can be seen when a price remains between the Upper and Middle Bollinger Bands. Any approach price towards the Middle Bollinger Band represents an opportunity to buy or go long. This is valid for a bullish trend, with the opposite true for a bearish trend (though a sell position would usually be taken here). Trending on bigger time frames can offer bigger support and resistance on pullbacks. This is arguably the most important reason as to why swing traders look toward these charts.

• • Position Traders – These guys are in it for the long haul. Position traders have trades that last for more than several weeks, months or even years. Generally speaking, their focus is predominantly on the fundamental aspects of market analysis, with technical factors taking the backseat.

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