As a trader, you have likely heard the old proverb – it is best to “trade with the trend.” The trend, say all gurus, is your friend. Of course, this is sage advice only to the extent you can accept that the trend can end. And then the trend becomes a stranger to you.
So how can we decide the trend direction? Here is a method of deciding the trend and a straightforward method of foreseeing the trend’s end.
We ought to underline the importance of time frames in defining the trend. Generally, when we are analysing long-term investments, the long-term time frame towers over the shorter time frames. However, the shorter time frame could be of greater value for intraday purposes. Trades can be categorised into three trading styles or segment classes: the intra-day, the swing, and the position trade.
Like those companies setting up production in a foreign country, big commercial traders might be interested in the currency’s fate over a long period of months or years. But, as far as speculators are concerned, a weekly chart is acceptable as “long-term.”
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Averages Moving in Pairs
With a weekly chart as the starting reference, we can thereon go about deciding the long-term trend interesting a speculative trader. Therefore, we have to resort to two very handy tools that will help us decide the trend. The two concerned tools are the simple moving average and the exponential moving average.
In the weekly chart overhead, you can see that for May 2006 until July 2008 period, the blue exponential moving average – 20 interval period – is elevated above the red 55 simple moving average both are sloping upward. This exhibits the trend is showing an ascent of the euro and thus a deteriorating dollar.
In August 2008, the short-term moving average in blue on the chart hereunder turned down, indicating a potential trend change, notwithstanding the fact of the long-term average (red) having not yet done so.
Discovering the trend change
In October 2021, the 20-day moving average surpassed the 55-day moving average. Both were sloping downward at the time. At the time of writing, there’s a switching of the trend to the downside. Hence, short positions against the euro would be thriving.
In Chart 2, we notice that the short-term moving average goes relatively flat in December 2008 and starts to turn up, indicating a potential trend change to the upside.
However, closer scrutiny of the 55-day moving average, with December 2008 as a reference, reveals that the long-term moving average has stayed downward sloping.
By scanning Chart 2, we can notice that the first arrow from the left shows that the long-term moving average has turned down, implying that the weekly or longer-term trend for the EUR/USD has now plummeted. The second arrow means a new short position could have been successfully taken if the price had traded back to the down-sloping moving average.
The objective here is to decide the trend direction. When to enter or exit a trade is not the focus. Naturally, this is not to deny that there were trading opportunities in the shorter time frames, for instance, the daily and hourly charts.
However, for those traders who wish to trade with the trend, instead of correction trading, one could wait for trend resumption, again trading in the trend direction.
Double Bottom Indicator
Let’s move over toto Chart 3 and see what occurs as the 20-day exponential moving average trades down to a double button. Provided that a double bottom on a chart implies support at the bottom, we can monitor the price action every day to deliver us an advance clue. The arrow reveals where the short-term moving average is shifting up.
We note that the moving averages are not operated as trading signals but only for trend direction purposes.
Get hold of a Wave
We can gauge the trend direction on a daily, weekly chart by fixing up a short-term exponential moving average and a longer-term simple moving average.
Knowing the trend does assist in taking positions. However, it is best to be mindful that the market movement is in waves. These waves are known as impulse waves when in the trend direction. Conversely, these are corrective waves when against the trend.
By calculating the waves or pivots in each wave, one can try to foresee if a trading opportunity will be with the trend or against the trend. Per the Elliot wave theory, an impulse wave generally is made up of five swings, and a corrective wave typically comprises 3 swings. A full-wave movement would comprise five swings. Simultaneously, two of the swings go counter-trend.
The image above gives an instance of an Elliot wave. Given that Elliot wave theory can be very personal, you are advised to operate a pivot count to help you decide on wave exhaustion. This usually implies a minimum of seven pivots when accompanying the trend, followed by five correction pivots. Of course, now and then, the market will not stand shoulder to shoulder with these technical assumptions. However, it can happen frequently enough to furnish some very profitable trading opportunities.
Conclusion
Trend trading is a strategy concerning the use of technical indicators for the identification of market momentum direction. Trend trading is generally thought a mid to long-term trading strategy. Theoretically, it can cover any timeframe, contingent upon the duration of the trend lasting.
Trend trading strategies are intended to help in pinpointing trends at the earliest. You can thus exit the market before trend reversals.
Across the board, there are three sorts of primary trend – downtrends, uptrends, and sideways trends. In addition, the most widespread trend trading strategies operate technical indicators. Among the latter, you can count the relative strength index (RSI), moving averages, and the average directional Index or ADX.
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