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Trading 101

Trading 101: Trends and a Basic Trend Following Strategy

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“The Trend is Your Friend”

Being one of the oldest, and probably overused, trading axiom, this is all too often overlooked by new traders. Still, if you are using technical analysis – whatever asset you are interested in – the first thing that you should be looking for is the prevailing trend. Why? Because the trend is the single most reliable predictor of a position’s success. Trading in the direction of the trend, also called trend-following, significantly increases the success rate of your positions, although it doesn’t guarantee that you will be profitable in itself.

[ecko_annotated header=”Try to trade in a pleasant tailwind” annotation=””][/ecko_annotated]

Trading against a trend on a given time frame is like running into a strong headwind, while trading in the direction of the trend is like enjoying a pleasant tailwind. Without a doubt, trend-reversal strategies can be very lucrative, but they are more for the experienced trader, as the success rate of those plays is low.

How can a strategy be lucrative with a low success rate, you might ask. It’s simple; several small losing trades and one huge winner that can turn into a long-term position might make those strategies attractive. But that’s exactly why they are for more seasoned players—for a beginner, it’s hard enough to make profits with a high success rate strategy, let alone endure the frustration of numerous losing positions.

So, for now, we will take study the simplest trend-following strategies and look at real-world examples of how to use them. Let’s start with job number one, identifying the trend.

The Three Types of Trends

For some, speaking about three distinct types of trends might be a surprise. But rising and falling trends don’t cover the whole picture. The third type, neutral trend, is as important as the two obvious market phases. In fact, on average, neutral trends account for as much as 60-70% of the price action of a financial asset. Understanding that will help you make sense of the day-to-day movements of your preferred assets, as well as the changing profitability of certain strategies over time.

The trends are different in many characteristics too; volatility, liquidity, the suitable strategies, the ease of trading… all of those change when the underlying trend changes. On an interesting note, there are “fake” rising and falling trends, as some assets move inversely compared to the market. Without getting into details now, some ETFs, currency pairs, and even commodities (mainly gold) tend to gain when stock markets fall and negative sentiment is dominant. This will lead to rising trends with bearish characteristics and falling trends with bullish characteristics. First, we will take a look at a generic advancing trend.

Rising Trends

Swing-lows and swing highs inside an uptrend in the S&P 500, 4-Hour Chart

As you can see on the chart above asset prices move in rising and falling “waves”. When a rising wave ends, we talk about a local (or swing) high or top. Conversely, when a falling wave ends, it’s called a local (or swing) low or bottom. These highs and lows are very important in trend analysis. Simply put, a rising trend on a given time-frame means that the asset reaches higher highs and higher lows with wave after wave.

Of course, real life trends are more complicated than that, but this simple analysis method is remarkably effective when judging the state of a market, even if irregular swings mess things up sometime. On another note, there is undoubtedly a subjective factor in defining highs and lows that could lead to somewhat different interpretations of the same price action.

With time, all traders develop a “feel” for swings that helps them in making quick and effective decisions. As you will see, identifying swing lows and swing highs is also essential for other analysis tools like trend-lines, divergences, support/resistance levels and so on… This means that every trader will have a slightly different analysis of the same asset even if they follow the same principles. Trend analysis (and technical analysis in general) is sometimes more an art than an exact science. That said, the strategies and the underlying logic remain the same for everyone, and in the long run, these small differences don’t matter that much— a trader’s success depends more on discipline and consistency.

The Characteristics of Rising Trends

A rising, or bullish, trend is generally a steady period. Volatility is low, trading volumes are also relatively low, and the steady rising waves are interrupted by short and usually shallow counter-trend moves. An increase in volatility or unusually high volumes might be interpreted as warning signs that the trend is about to end.

Trading in bullish trends is probably the easiest, but the least “exciting” for traders. Psychologically it can also be challenging to enter these trends, because of the shallow nature of the counter-trend moves, as you have to jump into the trend when ”it’s already up so much…”. As another old adage says,

“bulls markets won’t let you in and bear markets won’t let you out”.

Don’t worry we will help you in fighting those difficulties with our coming posts.

A basic swing trading strategy

Our first strategy will be a very simple one with lots of room for refinement, but the basic logic is the foundation of a vast number of profitable strategies.

  • Enter the trend when the price closes above a new high (surpasses the prior swing high)
  • Set the stop-loss at (or below) the prior swing low.
  • Move up the stop loss on every new swing low

Let’s take a look at our previous example for entry and exit points according to this strategy:

Entry and exit points of a basic swing trading strategy S&P 500, 4-Hour Chart

As you can see the strategy gives two clear entry- and exit-signals that capture a healthy chunk of the bullish moves, without any refinement. That said, the exits are far from being optimal, and position-management techniques could boost the returns of the strategy as well.

This strategy is designed to benefit from strong trending moves on any time-frame and sometimes it is also used as an “overlay strategy”, meaning that being on a “bullish or bearish swing” is used as a condition to boost the success rate for certain other shorter-term strategies.

The Characteristics of Falling Trends

Now that we introduced swing lows and swing highs, identifying falling, or bearish, trends will be easy. As you guessed, a series of lower lows and lower highs defines a bearish trend. Apart from the same structure, falling trends are fundamentally different than bullish trends. Volatility is usually high, price action is vicious, and the counter-trend moves are also wild. In general, bearish trends are much harder to trade, even if the larger moves make them look attractive for the novice trader. In reality, even experienced players can struggle to make consistent profits in falling markets.

Let’s take a look at the chart below to see the differences in practice (method used is shorting):

Entry and exit points of the basic swing trading strategy, USO, Daily Chart

The structure of the bearish trend is similar to our bullish example (with two distinct trending moves and consolidation periods), but especially the counter-trend moves are strikingly different. Volatility is high, and highs and lows follow each other in quick succession. Although our basic strategy remains profitable, actually trading upon these entry and exit points is much harder. Why? Well, in real time, the wild moves and the relatively large change in your profits make things that much more difficult. Also, notice the false entry point towards the end of the period—those are much more common in the volatile environment of falling trends.

Of course, with adequate position sizing techniques, more refined strategies, and risk management, bearish trends can be traded successfully, but beginners should focus their attention on rising trends. You might have noticed the trend-lines that we drew on our example charts. Being the next logical step in trend analysis, we chose to put them on the charts to help you recognize the power of them.

Trend-lines can give you early warning signs for changes in the trend; they can help you in refining your entry- and exit-points, and much more. So in our next post, we will take a close look at trend-lines, and how to utilize them. We will also dedicate a whole post on neutral trends, as they need a bit different approach compared to bullish and bearish trends.

Previous article: What Can You Achieve With Trading?

Next 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 379 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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3 Comments

3 Comments

  1. Ershad

    April 9, 2017 at 8:31 pm

    Hi Cser,

    I recently joined hacked and I’m pleased with the level of information provided. I’m a complete new trader with limited expierence and was going to ask if you can help me understand this post better regarding of when to enter the market, what do you mean by ‘prices closes above a new high’ would this be identified by looking at the candels? Also do you by any chance offer maybe 10 mins a day or even a week tutorial by Skype as I’m really interested in trading cryptocurrencies and gold. I already have made an investment into both but I would highly appreciate if you can help me understand trading better.

    Thanks
    Ershad

    • Mate Cser

      April 9, 2017 at 10:41 pm

      Hi Ershad,

      thank you for your comment! We will be offering one-to-one consultations in the near future. We will announce that to all of our members so you won’t miss out on it.

      Regarding the specific question, yes the closing price can be read off the candlestick. A green (rising) candlestick’s closing price is the top line of the green part (body) of the candle, while a red (declining) candlestick’s closing price is the bottom line of the red part of the candle. In this strategy, the closing price determines the entries and exits.

      Feel free to ask anything here until the consultations go live!

      Great trading,
      Mate

  2. SirPrime

    June 18, 2017 at 3:37 am

    Hello Cser.

    I think this kind of strategy is good for any lapse of time, but do you recommend take 1 year of chart or, maybe, 1 month, 6 hours… etc. And about the candles width, it is good to take 15min or 1 hour, etc?

    Thanks,

    Fredy

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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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