„Go with the flow, ride the tide, bend with the trend“. Quote from Bill Willams.
It sounds easy, does it not? But trading with the trend is not as simple as the quote will let you believe! And many Forex traders, I’m sure, are well of aware of that and would agree.
Last week we discussed entry methodologies (early entry, confirmation entry, momentum entry) in the Forex trading versus the various types or markets (trend, counter-trend, range). Today we will focus on the latter.
TRADING WITH THE TREND
In theory trading with the trend is the classical remedy for trading profitably. When anyone starts out with trading, they quickly discover a common used wisdom that traders earn the most pips and Return on Equity when they trade with the trend and avoid counter trend trading and range trading. The optimal methodology is to buy on dips and sell on rallies. That message is very straight forward and simple.
And yes, the advice is excellent and worth gold, or at least many pips. As you might know if you are a member of our trading room, trending with the trend is our primary focus when analyzing the market and taking trade setups.
Defining the trend is important in order for the Forex trader to recognize in what environment they are trading. Only by defining the trend is the trader able to mark the current market structure as trending, counter trending or ranging. Remember though that defining the trend is only part of the job Forex traders must complete. Traders should also check:
1) for filters which could hinder the trade
2) what they consider as the opportunity
3) their entry methodology and trade plan
4) a decisive method of entering.
Although the art and science of trading with the trend is easy to understand from a conceptual point of view, it is not as straightforward as it seems and takes experience to implement with actual trading in a live trading environment.
DIFFICULTIES WITH TREND
When trading with the trend, I believe there are some difficulties which jump out when applying the knowledge in real life. I will list the most problematic issues, which I believe hamper successful trend trading, but I encourage you to participate as well by writing down below in the comments section. Do you encounter difficulties when analyzing or trading the trend? If so, why and how does that happen?
Sometimes interestingly enough, the beginner trader has a lucky start with great winning trades and lots of profit. Did you ever wonder why? In most cases the lucky start is because they traded with the trend. The problem is that the newbie trader is unaware of the reasons for their success and continues implementing the same strategy until they start losing their money again. What the new trader does not realize is that the market environment has changed for that particular product and they are no longer in a trend. When the market was trending, they made loads of pips because they were riding the tide and going with the flow, remarkably with little trading psychology issues because they had yet to encounter a serious setback. However, unavoidably the particular currency pair stopped trending at one point or another and they were unable to switch gears when that happened.
Traders, who do not quit at this point time, often enough attempt to find a solution by looking for different trading methods. However, it was not their trading method that failed. Their knowledge and experience could not sufficiently cope with the challenging task of defining the trend and trading with the trend.
Eventually when a trader develops from a beginning trader to a developing trader, other difficulties arise. Contrary to the beginner, the developing trader is well aware of the fact that trading with the trend is desirable. However, other problems loom in the horizon.
1.) Defining the trend – defining the trend from a theoretical point of view is only half the battle, interrupting the market in practical real life situations is often a lot more complex for traders
2.) Trading psychology – fear and greed are usually tossing a trader from one thought to another. A setback could persuade a Forex trader not to focus on the trend or to change their trend definition for the 10th time. A trader might not fully trust the trend or the reasons why it is important. A trader might not fully trust their own definition of the trend or have setbacks when analyzing multiple time frames.
3.) The trading mentality – another problem that could occur is our own mental state of needing a trade. Trading with the trend means a Forex trader needs to have patience for a trend to develop. A trader needs to wait for the right circumstances to emerge. If a trader is chasing the market, then the best trend definition in the world is not going to help. Read here more about chasing the market.
Keeping our focus, mind set and vision on trading with the trend is not as easy as it seems. Many times our brains will imagine a reversal setting up or have fear for trading with the trend because we are scared that a trend could end. Of course a trend will end one day but it could take very long before that happens and more often than not miss many with the trend trades. For traders it can be sometimes difficult to believe that the trend will continue and they become (overly) focused on catching the exact reversal. Often enough they are caught by surprise when the trend continues. Instead, they focused on the potential reversal and missed the opportunity to join the trend.
SOLUTIONS FOR TREND TRADING
I will present to you my methodology of defining the trend. However, please write down in the comment section down below what your methods are! What do you use for the trend? Have you changed it? Are you happy with it or still unsure?
First of all, I am swing and target trader. I do not aim for 2-3 pips when entering a trade. So for me the trend definition is completed primarily on the 4 hour chart and day chart. I do not need both of these time frames to show me a trending mode in the same direction. What I do want is one of the two time frames to show a trend and the other to be considered a pullback (corrective price action) or the other to be in a range. Of course the best situation is when both time frames are in trending in the same direction.
If you are trading on lower timeframes, then it would be advisable to focus only on the 4 hour chart and not the day chart for trend definition. Or focus on a combination of 1 and 4 hour charts.
If you are trading on higher timeframes, then it would be advisable to focus only on the day chart and not on the 4 hour chart for trend definition. Or if you are a position trader, then use the weekly and monthly charts for the trend definition and the daily for entries.
Point is that every Forex trader should choose 1 timeframe, maximum 2, for their trend definition. This trend definition must always be 2-3 time frames higher than the one of entry.
a) when entering on 5 min chart use 1 hour charts for trend,
b) entering on 15 min charts use 4 hour,
c) entering on hourly use 4hr/daily,
d) entering on 4 hour use daily/weekly,
e) entering on daily use weekly/monthly).
In our methodology of defining the trend we emphasize two types of trend definition.
First of all, in our trading room we definitely use the classical textbook definition for trading with the trend:
- Higher highs and higher lows for an uptrend
- Lower lows and lower highs for a downtrend
There is no magic formula or secret combination of indicators. Using the classical definition for trends is what I would advise, but it takes experience to be able to translate the different stories of the various time frames. Even if you use one time frame for your trend definition, then you still want to use filters on other time frames in order to avoid taking longs right in front of a resistance and go short right in front of a bottom.
Second of all, in our trading room we use classical trend lines, trend channels and a moving average to decipher the currency. The tools help distinguish whether we are looking to trade the currency or not, and if so in which direction. It also shows us the angle of the trend, and gives us an understanding of timing and profit potential within the trend.
Having a trend is great but it does not mean that we should immediately be buyers in an uptrend, nor sellers in a down trend. All it says is that we have a green light to trade the currency pair long or short. Remember, our goal is to be realistic with the trend traders, not the lucky ones mentioned at the beginning 🙂
How we exactly define the trend, how we use the trend definition to benefit our trading, and how we make the complex task of multiple time frames look simple is what show in our trading room day in and day out. I will reveal all of those trend definition wisdoms but in our next article!
Make sure to check out the next Friday article where we dive into exact details of defining the trend.
In the meantime I wish you Good Trading, a great weekend and talk soon.
Oh and if you are in need of more guidance on NFP trading, take a look here.
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