Trading With The Trend
Trading with the trend is the process of identifying what the price trend is and then trading with it.
This can be a small price trend or a larger one but in its most basic form, the price has to trend in the direction of your trade in order to make money.
Whatever the price difference is between the buy and sell price, this is your profit.
However, there is more to it than that because these price trends can be in the direction of longer term trends or counter to them.
In this article you will learn what trading with the trend is, how to identify them and how to start trading with the trend.
So keep reading to learn more.
Without further delay, let’s get straight in to it.
What is trading with the trend
Trading with the trend is a strategy that involves identifying and trading with the dominant price momentum or bias of a currency pair.
The price moves in a wave like fashion which depends on the order flow and the sentiment of market participants.
Over time, these waves can oscillate with a bias that takes the price higher or lower creating short, medium and longer term trends.
What are price trends
Price trends are relatively easy to spot.
They are categorized as a series of higher highs and higher lows for an uptrend.
For a down trend, it is a series of lower lows and lower highs.
In an uptrend and downtrend, price demonstrates its propensity to continue trading higher or lower respectively. On a price chart, you can identify this as price making a series of higher highs and higher lows.
In either case, of a bullish uptrend or a bearish downtrend, price has a natural tendency to behave in a particular way. Its either moving up over time in the case of the former or down over time in the case of the latter.
Check the image below to see what I mean.
That should be simple enough to understand.
Price and time are the two relevant variables involved when identifying the trend.
When the market is in a trending phase, trading with the trend is the most prudent thing to do. Because the price momentum will probably remain on your side.
Trading with the trend increases the probability of making money and this is the main advantage of trading with the trend.
The trend is your friend
Trading can be as simple as tracking down the trend and trading with it but that does not mean that trading is easy.
Because the market is fractal in nature and anything can happen at any time;
“A fractal is a never-ending pattern. Fractals are infinitely complex patterns that are self-similar across different scales. They are created by repeating a simple process over and over in an ongoing feedback loop” - Fractalfoundation.org
In regards to price behavior, this means that price patterns and price trends exist within larger ones. A longer term price trend is made up of medium term price trends. Medium term price trends are made up of shorter term price trends.
In other words, price might be trending up on a 15 minute chart but on a daily chart, the price trend could be down.
Furthermore, there are corrective price trends of larger waves and continuations of the existing price trend after a corrective phase. These are also known as pull backs and impulsive waves respectively.
From whatever perspective you look at price to determine the trend, there will likely be some contradiction about the possible future direction of price. That is the challenge in identifying the trend.
This is what I mean.
Trading with the trend requires tracking it and correctly identifying what phase it is currently on. With meticulous analysis and practice, it is possible to predict so you can trade accordingly.
When you are confident that a corrective phase is over, or there is confluence of trend direction across multiple time frames, you can trade in the direction of the next continuation wave.
How to identify a trend and determine its direction
The best way to conduct your analysis is with a top down approach.
Start by analyzing the higher time frames to understand the bigger picture and then work your way down to the lower time frames.
The higher time frames will help you to identify the dominant price trend. The lower ones will help you identify whether there is confluence or not.
All trends begin with an impulsive wave, either up or down.
Then there will be a corrective wave that retraces some of the initial impulse.
At some point in time, price will either create a higher low or a lower high for an uptrend or downtrend respectively.
Price should then continue with another impulsive wave in the same direction as the previous one.
Here is an illustration of this for the case of an up or bullish trend. It is inverted for a down or bearish price trend.
This is potentially the beginning of a trend only because it is an early sign that price is starting to put in higher lows and higher highs. However, there isn’t adequate confirmation to classify this as an uptrend yet.
You need to pay attention to what happens next.
By similarly repeating impulsive and corrective wave patterns over and over again, an uptrend in price can become evident.
If this is really the beginning of an up or bullish price trend, price shouldn’t violate the previous low on the next correction. A second corrective wave is likely and this low should not lower than the previous low. Then a third impulsive wave higher can be anticipated.
If the third impulsive wave creates a new higher high, then you have a trend.
However, it is possible that the price loses momentum on the next wave up to create a lower high before reversing.
One impulsive wave does not constitute a trend. The second impulsive wave making a higher high can be considered as coincidence. Two higher lows and a third impulsive wave creating another higher high is a trend.
For as long as the price is making higher highs and higher lows (or at least equal lows) the momentum is up. In this example, trading with the trend requires having a bullish bias and anticipating the next impulsive wave higher.
How to trade price trends
By now, you should know what trading with the trend is and how to identify one. The remainder of this article will show you how to trade price trends.
Although there are various ways to do this, there are typically two entry techniques when trading with the trend.
You can either buy the dips and sell the rallies in an uptrend or downtrend respectively. Or you can enter when the price breaks out above or below previous highs or lows.
Each technique has its advantages and disadvantages. Let’s look at each of them.
Buying the dips or selling the rallies in an up or down trend respectively, involves entering the market as soon as possible after a correction has matured. The entry in to the market occurs after the price correction and when it starts to show signs that the trend will resume.
This technique allows you to trade with the trend ahead of the next impulsive wave with a more advantageous price. However, there is a risk that the correction is not yet over and will continue.
This is what buying dips and selling rallies looks like when trading with the trend.
The alternative technique is to trade the break out or break down. This means buying when price breaks out of previous highs or selling when price breaks down, out of previous lows.
Entering the market using this technique is delayed compared to the previous one. You will also get a worse price. However, it does provide more confirmation that the dip or rally’s bottom or top has been established and the next phase of the trend is underway.
This is what buying break outs and selling break downs looks like when trading with the trend.
Notice that the entry in to the market occurs when the price “breaks” in to new highs or lows.
Money management techniques when trading with the trend
Both techniques are commonly used among traders; it just depends on what they are comfortable using as part of their trend trading strategy.
In either case, with every trade, a stop loss should be placed as well as a take profit.
Stop losses are usually placed at the earliest price that would invalidate the idea or the price trend.
Profit targets are usually placed at the next support or resistance area based on previous price structure. This can be estimated by looking back at what happened in the past.
This is not the only way to do it though. You can simply trail the stop loss below the most recent highs or lows and let the profits run.
When buying dips or selling rallies, stop losses can be placed below the current or previous lows. As this is the earliest point that invalidates the current price trend and could suggest that the trend is reversing.
If the trend is going to continue, price should continue making higher highs and higher lows in an uptrend. And lower lows and lower highs in a down trend.
Profit targets can be placed from the previous high or low and you can even hold the trade to ride the trend to higher or lower prices.
This is what I mean and you can just invert this when selling rallies in a down trend.
When buying break outs or selling break downs, stop losses can also be placed below the current or previous highs or lows. As this is the earliest point that might suggest that the trend is reversing.
Notice when using this technique, the stop loss placement is naturally wider. In order to maximize your profit potential, it might be necessary to sit through some price corrections.
This is what I mean and this is also inverted for selling break downs in a down trend.
The profit target can be some time after the price makes a new high or low and the stop loss can be below the recent or previous high or low. Alternatively you can hold the trade and ride the trend for even greater profit potential.
Summary to start trading with the trend
So let’s summarize everything with an example that demonstrates how a simple trend following strategy could work.
The first thing to do is to identify the longer term price momentum. Is the trend bullish or bearish? You can use a higher time frame to help you do this. Trading with the trend involves trading in the same direction as the dominant price momentum.
So if the longer term trend is up, you should only be looking for buys. If the longer term trend is down, you should only be looking for sells.
Once you have adequate confirmation of the direction of the longer term trend, you can start looking for entry signals to buy or sell.
There are two common trading techniques to enter the market. The first one is to buy the dips in an uptrend and sell the rallies in a downtrend. The second one is to enter when the price makes a new high or low in an uptrend or downtrend respectively.
For the former technique, you should wait for a signal that indicates that the pullback is exhausted and the next impulsive wave is likely to start. This could be a shorter term trend confluence on a lower time frame.
For the latter technique, you can enter the market as soon as the price makes a higher high or a lower low, in an uptrend and downtrend respectively.
Then it is all about trade and money management.
You can either set a stop loss and project a profit target or trail your stop loss and try to ride the trend for as long as the trend remains intact.
Using the former money management technique can limit the profit potential of a trade but it can also reduce how much is left on the table in case the trend turns.
Using the latter technique can maximize a trade’s profit potential if the trend remains intact for large price movements. However it might result in frequent stop outs and giving too much back to the market.