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Trading 101

Trading 101: Trend Analysis with Basic Charting Tools

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In our previous post dealing with swing trading we laid off the basics off trends in financial markets, and now we are going one step further. Getting to know the simplest charting tools will help you in analyzing trends, refining entries and exits, and building more sophisticated strategies. What’s more, these easy-to-use tools will be helpful not just in trading, but in your long-term investment decisions as well.

For those who hear the terms “charting” and “charting tools” first, charting is the name of the analysis of price charts which contain the price history of financial assets, while charting tools are various drawings like trend-lines, chart patterns, support and resistance levels, and other visuals that traders use for their decisions.

We will get to all the different chart types (and later the hundreds of indicators that are out there), but for now, this is more than enough to progress. In fact, as you will see, keeping your analysis simple should be one of your most important long-term goals as a trader.

The Role of Charting Tools and Indicators

Before we get into the tools themselves, it’s crucial to note that charting tools and most trading indicators have one very important thing in common; they don’t add additional information to the price (and volume) data that’s already available on a basic price chart. This means that they are not some sort of magical forecasting methods. That said, by visualizing the data in different ways, they can uncover hidden, or hard to understand tendencies in the price history of an asset, making them very useful in practice.

OK, but why do traders need that information? Well, the basic premise of technical analysis is that by studying the price history of an asset, we can predict the probability of the direction of future price movements.

The word probability is very important here because, without it, it’s easy to misunderstand technical analysis and charting tools. The key is that these methods don’t predict the future (because that’s not possible), but they help you in taking the position with the highest probability. Indicators will also be of great help in this process, providing simple and convenient ways of discovering ongoing trends, cycles, and waves in the price action.

The Structure of Trends

As we have seen previously, prices move in advancing and declining waves (or swings) that are separated by swing highs and swing lows. The most basic tools of trend analysis are trend lines, which simply connect these swing highs and swing lows. On the chart below, you can see that these trend-lines give traders a good idea of the”angle” of a certain price movement.

Rising and falling trend-lines in the EUR/USD currency pair

The trend-lines connecting swing lows and swing highs usually form a trend-channel that defines the movement of an asset for the period of the trend.  Because trends can be broken down into smaller waves on shorter time-frames, there are most of the times several “active” trends in motion for every asset. You can see those different trends (the lower time-frame trends drawn with red) on the chart below:

Rising and falling trend-lines on different time-frames

For our example, we deliberately chose trends that are not perfect (notice the small deviations from the trend-lines), as trend-lines are rarely precise enough to base exact trading decisions on them; they are more for roughly estimating the angle of the trend and the end of the price waves.

Cycles and Trend-Lines

You might ask the question that how it’s possible to spot a meaningful swing low or swing high on a given time-frame. The answer lies in cycles, which we indicated on the next chart. The swings on a time-frame tend to be roughly similar in length, giving you a good estimate for the length of the coming cycles. Using this, when a trend is established (after you identify a higher high and a higher low, or a lower high and a lower low), you simply project the length of the first wave (Cycle 1 on the chart) to get the possible points for the next swing lows (the vertical purple lines on the chart).

Cycles and swing lows in a rising trend

Again, these tools are not 100% precise, but they can help you immensely in your timing decisions. The major swing lows in our example were roughly around the projected cycle lows, and they were confirmed by the break of the lower time-frame trend lines. This is how a larger time-frame trend develops from shorter time-frame trends and major swings. In a rising trend, swing lows are more important, but the same logic can be applied for swing highs as well.

Trend-Line Signals

Trend-lines provide great value in several swing trading and other types of strategies as secondary signals. Secondary trading signals are signals that are less reliable but often come earlier, than primary signals, such as higher highs or higher lows. If the price reaches a trend-line it often means that the lower time-frame trend is close to its end, while a trend-line break is often a sign of the weakening the prevailing trend. These might provide the perfect opportunities for profit taking, switching to a more aggressive stop-loss level, or conversely, re-entering into a full position.

Let’s look at this in practice on the next chart:

Secondary trend-line signals in a rising trend

For this example let’s assume that you are already bought the asset in question, so we can fully understand the role of secondary signals. As soon as we established the trend-lines by identifying the higher high and the higher low, we can start using those for trading.

As you can see, this trend gave 3 clear profit taking points when the price touched the upper trend-line and two re-entry points when the price touched the lower boundary and broke above the declining shorter-term trend-line. It also gave an early warning to exit the whole trade before the price finally broke below a major swing low, providing a swing trading exit. This last signal is a good example when a trend-line break can serve as a primary signal—a clear break of a long-term trend often proves to be the end of a move or at least the start of a major correction.

Parabolic Trends

Some of you might already know about trends that are not exactly like the ones we discussed so far. Trends in financial markets can’t always be described by straight lines. Why? There could be several reasons for that—the cause of the trend might not be stable, the trend might attract more and more traders causing an acceleration in the trend, or conversely, a negative trend might cause a quickly spreading panic among the holders of the asset, leading to a swift collapse.

Whatever is the reason, these so-called parabolic trends are great opportunities for traders. As the moves accelerate, profits can pile up quickly if you are positioned correctly. That said, identifying these trends is not always easy, and the jump in volatility usually causes troubles for beginners, especially if they try to trade against these powerful moves.  For those reasons, we will dedicate a whole post for these trends; until then here is a recent example of a parabolic move:

A recent parabolic short-term advance in gold

What’s next?

Now that we introduced trends, the most important analysis tools for traders, in our next posts on we will take a look at some other crucial elements of charting, which complement and refine your trend analysis. Support and resistance levels, chart patterns, and special candlesticks will be on the menu.

Previous article: Trading vs. Investing

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.6 stars on average, based on 380 rated postsTrader and financial analyst, with 10 years of experience in the field. An expert in technical analysis and risk management, but also an avid practitioner of value investment and passive strategies, with a passion towards anything that is connected to the market.




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4 Comments

4 Comments

  1. sambkf

    May 4, 2017 at 9:47 pm

    Thank you for the great visual example of trend lines.

  2. dgimness

    June 11, 2017 at 5:32 pm

    Good article Mate!

  3. betom

    September 19, 2018 at 6:58 pm

    Thanks!

  4. Caohuynher

    September 25, 2018 at 6:12 pm

    I ứng by bitcoin

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Trading 101

Trading 101: 4 Reliable Chart Patterns in Crypto Trading

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Graph

In our previous piece on chart patterns, we pointed out that the way to use patterns is to judge probabilities that a certain move will happen rather than to view them as some holy grail in the market (which unfortunately doesn’t exist to my knowledge).

Although they aren’t holy grails, chart patterns are some of the best tools we can use to trade the markets with a surprising degree of accuracy. For example, some estimate that a well-known pattern like the head & shoulders have an accuracy of more than 80% when it is complete. Very few indicators can match that!

In this article, we’ll go over the 4 best chart patterns to use in crypto trading, teach you how to spot them in the charts, and show you how to trade them.

1. Head & shoulders pattern

Since I already singled out the head & shoulders as the most accurate pattern, let’s start with this classic chart pattern that most people have heard about and probably have an idea what should look like.

head and shoulders

The head & shoulders pattern generally signals a reversal in the market, as it is essentially a failed attempt of a trend to move higher. As we know, an uptrend is defined as a series of higher highs and higher lows, but in the case of the head & shoulder, the last trend wave fails at making a higher high and higher low, and a new downtrend is initiated. The opposite pattern, known as an inverse head & shoulder, signals a shift from a downtrend to an uptrend.

Since the head & shoulder is so well-known by now, and the logic is based on simple trend trading, it is often considered to be the most reliable pattern in trading. It can often be easier to spot on a line chart as it can help you filter out all the clutter otherwise found on candlestick charts.

2. Bull flag

This is a continuation pattern and is also considered one of the most reliable bullish patterns we have. Sometimes also called a pennant or a wedge, these names all essentially refer to the same thing.

Bull flag

The bull flag is formed when price enters a consolidation phase following a strong uptrend. What really happens when price is consolidating is that the market is gathering momentum for the next burst up. It is a natural part of a trend where those who have been with the trend from the beginning are taking the opportunity to realize some of their profits, while new traders are entering the market and positioning themselves for the next run-up in prices.

3. Cup and handle

First introduced in William O’Neil’s book How to Make Money in Stocks, the cup and handle pattern is a bullish chart pattern that is very well-known in the stock market, but also appears to work well in other markets.

According to O’Neil, the pattern should span a period of 1 to 6 months in the stock market. In crypto, where everything moves faster, this period can safely be cut in half. For the pattern to be more reliable, we would ideally want to see a significant rise in trading volume near the end of the handle as price begins to rise. A buy order should be entered as price breaks above the high made by the right side of the cup.

The logic behind the pattern is the same as for the head & shoulder and trend waves: the cup represents the bottom in the market and the handle creates a higher low, which by definition means that an uptrend has started.

4. Rectangle

The rectangle is a similar pattern to the bull flag and trading channels, where price appears to be “stuck” between two imaginary lines on the chart. The more touches we have between these outer lines and the price, the more reliable the pattern is considered to be.

The rectangle is a trend continuation pattern, and often becomes a waiting game for traders since it is difficult to tell exactly when the price will break out of the pattern. However, the pattern is fairly reliable at predicting the direction price will break out in. The rectangle can be either bullish or bearish, depending on the direction of the preceding trend.

The pattern can be traded either by placing an order when price is close to the lower end of the rectangle with a stop just below the lower line and then waiting for price to break out. Alternatively, you can place a buy order just above the upper end of the rectangle in hopes of catching the trade as the price breaks out. The danger with the last option is that fake-outs where price spikes up just to fall back down do occur quite frequently. As always in trading, taking a slightly more conservative approach may serve you well over the long-term.

Featured image from Pixabay.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.3 stars on average, based on 37 rated postsFredrik Vold is an entrepreneur, financial writer, and technical analysis enthusiast. He has been working and traveling in Asia for several years, and is currently based out of Beijing, China. He closely follows stocks, forex and cryptocurrencies, and is always looking for the next great alternative investment opportunity.




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Trading 101

Lessons from The Turtle Traders

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turtle traders

For those of you who haven’t heard about the so-called turtle traders before, I’ll give you a brief recap here: “The turtles” were a group of laymen traders who were chosen more or less randomly to be coached by two of the pioneers in trend-following trading; Richard Dennis and William Eckhardt.

While Dennis, who had already made more than $100 million in the markets, were convinced that anyone could learn to trade, Eckhardt argued that Dennis was a gifted trader and that it would be extremely difficult for someone else to replicate his success. Unable to come to an agreement, the two men figured that the only way to settle the dispute would be to conduct an experiment where they would teach ordinary people their own trading system, and then measure the results.

As the story goes, the turtles became hugely successful, and Dennis was proven right.

Their story became known to world mainly through Michael Covel’s books Trend Following and The Complete Turtle Trader, where he shared some previously unknown details about the very simple trading strategies and methods used by “the turtles.”

Although the turtle experiment took place back in the early 1980s, the lessons learned from the experiment are as valid in today’s crypto market as they were in the commodities market Eckhardt and Dennis were trading in back then. In this post, I therefore wanted to share some of methods used by the turtles that can hopefully help you improve your own trading performance as well.

If you are interested in learning more about the methods the turtles used, I recommend reading Covel’s book to get the full story.

ATR as stop-loss

Using the Average True Range (ATR) indicator as a trailing stop-loss is something I learned from Covel’s book about trend following and that I’ve used successfully over the years, as I wrote about in another post about a trend following trading strategy.

Generally, the idea of using trailing stops in trading is that it allows you to ride the trend for longer, without taking on unnecessary risk. It is also in the very essence of trend following trading that traders should not try to predict where a trend will start or stop, but instead simply react to what the price is telling them. In this context, if the price breaks through the ATR line you have drawn up on the chart, it is telling you that the trend has ended and it is time to get out of the trade.

The ATR is calculated based on the volatility of the asset, which means that perfectly normal market movements will be classified as noise, and only extraordinary movements to either side will lead to price breaking through the ATR line.

TradingView has a very useful built-in indicator for using the ATR as a trailing stop called “ATR Stops.”

Maximum 2% risk on each trade

Since the turtles used the ATR as their stop-loss, the risk in terms of pips on each trade would naturally vary depending on the asset they traded. However, by adjusting their position size, they still managed to keep their risk at no more than 2% of their trading account on any one trade.

Pyramiding

Pyramiding is the concept of adding to a winning trade as time passes. This is pretty much the opposite of conventional value-based investing wisdom, where it is usually preached to buy low and sell high. The turtle traders, on the other hand, were not afraid to buy high and sell when things were moving against them (buy high, sell low).

The turtle traders usually didn’t move in with the full position size that their risk management allowed on the first order, but would instead spread out their orders and buy more as the trade moved in their favor. For example, they would enter an order with a position size that kept their risk at 0.5% of their capital as a trend started to form, and then enter new orders as the trend continued until they reached the 2% risk that their system allowed for.

This protected their downside if the trade moved against them from the start while at the same time enabled them to ride the trends until the end.

Reduce risk during losing streaks

The turtles were very aware of the emotional drawdown that follows a loss in the market, and they understood that because of this, losses tend to follow each other and create losing streaks from which traders sometimes never recover.

Because of this, Dennis and Eckhardt introduced a rule saying that if an account is down by 10%, the trader must adjust his risk as if he has lost 20%. With a smaller trading account left, the trader would then be forced to reduce his risk on each trade in order to stay within the maximum 2% risk allowed on each trade.

Not only did this save the turtle traders’ trading capital, but it saved their emotional capital as well.

Keep it simple

Lastly, it is important to remember that the exact trading system the turtles used was relatively simple and straightforward. Trend following trading is often like this, and it has been proven over and over again that simple and robust systems beats complicated strategies. As Richard Dennis was quoted as saying in the Market Wizards book:

“I always say that you could publish my trading rules in the newspaper and no one will follow them. The key is consistency and discipline. Almost anybody can make up a list of rules that are 80% as good as what we taught our people. What they couldn’t do is give them the confidence to stick with those rules even when things are going bad.”

Featured image from Pixabay.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.3 stars on average, based on 37 rated postsFredrik Vold is an entrepreneur, financial writer, and technical analysis enthusiast. He has been working and traveling in Asia for several years, and is currently based out of Beijing, China. He closely follows stocks, forex and cryptocurrencies, and is always looking for the next great alternative investment opportunity.




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Trading 101

Trading 101: Determining and Trading Trend Strength

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Trend-following trading remains the most popular approach to trading in the retail segment, both in crypto and other markets. However, before taking positions in the direction of a trend, it is crucial to determine if the trend is gaining or losing strength. As trend traders, we need to make sure we are only taking trades in trends that are building up, and not those that are fading.

While we have covered the basics of trend-following trading in the past, and also revealed several trend-following strategies, we will here focus on how you can determine if a trend is worth trading, using both systematic and discretionary tools.

Trend waves and pullbacks

Studying trend waves and pullbacks during a trend forms the basis of a discretionary approach to determining trend strength.

In a trending market, small pullbacks signal strength in the trend. If each pullback is getting increasingly smaller as the trend continues, we can say that the trend is picking up momentum. Another thing we often see in strong bullish trends in that the pullback is not really a pullback, but rather a sideways consolidation of the price. This indicates that bulls are strongly in control of the market, buying up even the smallest dip in prices.

On the other hand, as pullbacks get larger and occur more frequently, we can take it as a sign that the trend is losing momentum and the price may reverse into the opposite direction soon.

Moving Averages

Moving Averages are probably some of the best-known tools for trend traders, and for good reason. They are incredibly simple to use, and can provide powerful signals in almost all markets.

The most common way to determine trend strength with Moving Averages is to apply two Moving Average lines to the chart; one slower and one faster. For example, combining the 20 and 50 period Moving Averages is a common strategy among swing traders in both forex, stocks, and crypto (the lower the period setting of the Moving Average is, the faster it reacts to changes in the price).

In a strong uptrend, we should have the faster moving average staying consistently above the slower Moving Average. If the distance between the two moving average lines grows, it means that the trend is gaining momentum, and if the distance between them shrinks, the trend is losing momentum.

If the two lines cross over each other, this is often taken as a sign that the trend is about to reverse. Many successful trend-following strategies follow the simple logic of buying an asset when the faster Moving Average crosses over the slower one, and selling an asset when the slower Moving Average crosses over the faster one.

Price rejection

What we call rejection of higher or lower prices in technical analysis is most easily spotted using traditional candlestick charts and looking for long wicks sticking out either above or below the “body” of the candles, as in the screenshot below.

Price rejection

In this chart, we can clearly see that we had a strong bullish trend and that the price attempted to extent the trend further, but repeatedly got rejected by the market. After four attempts at going higher, this market lost all bullishness and went into an extended downtrend.

Relative Strength Index (RSI)

As the name implies, RSI is an indicator that measures strength. In just the same way as we define an uptrend in price as a series of higher lows and higher highs, the RSI line should also make higher lows and higher highs when the market is trending up. In non-trending (range-bound) markets, the RSI generally moves sideways and stays between readings of 30 and 70.

As trends come to an end, we sometimes see divergences between the trend of the RSI and the price itself. For example, price may be making a new higher high, while the RSI line fails at making a new high, or even makes a new lower high, as we have two examples of in the screenshot below:

RSI divergence

Average Directional Index (ADX)

This is the classic trend indicator that many traders still use. The indicator consists of a red line and a green line and it basically says that a green line above a red line means we are in an uptrend. In the opposite case, a red line above a green line would mean that we are in a downtrend. If the two lines are close together it means that the market is not clearly trending, but rather stuck in a range.

Trend-following strategies sometimes make use of the ADX indicator in combination with Moving Averages to find strong price trends to ride. The ADX could then help determine the strength of the trend while for example cross-overs of two Moving Averages could serve as entry and exit points.

Which one should you use?

Perhaps unfortunately, which specific indicator to use in your trend-following trading really comes down to personal preferences. There is no right or wrong indicator to use, nor is there any right or wrong way to combine indicators and create your own trading strategy.

That said, most traders try to avoid combining indicators that are measuring the same thing. For example, ADX, Moving Averages and MACD are all considered trend indicators, while RSI and Stochastic are considered momentum indicators. In other words, you could combine Moving Averages and RSI, but should avoid combining Moving Averages and ADX with each other.

Experimentation is also fine, but instead of trying to learn how to use lots of different indicators, a better strategy is generally to use a few and become an expert at them. They are all powerful in their own way, it just comes down to the trader to master them.

Featured image from Pixabay.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.3 stars on average, based on 37 rated postsFredrik Vold is an entrepreneur, financial writer, and technical analysis enthusiast. He has been working and traveling in Asia for several years, and is currently based out of Beijing, China. He closely follows stocks, forex and cryptocurrencies, and is always looking for the next great alternative investment opportunity.




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