Trends
I am willing to bet that almost every person that has attempted to trade has heard some variation of "you should follow the trend" spoken as gospel. There are many traders who use a system called "trend following". Of course, this type of system is more complicated than just looking to see if prices are going up or down. But to the novice, this sounds like easy money.
In fact, on this very site I have seen multiple comments to my features that basically say "this is so complicated, all you have to do is follow the trend...trading is easy!" Needless to say, it isn't that simple. First, we must decide how to define an uptrend and a downtrend. The easiest way to do this, is by looking at a plain old chart. If there are consecutive lower lows and consecutive lower highs, that is a downtrend. If there are consecutive higher lows and consecutive higher highs, that is an uptrend. That part really is that simple. There are many tools available to help traders identify the trend though. Moving averages are among the most common.
The problem with moving averages is that they change when you change the chart. By changing the time frame of the chart and the number of periods factored in, you can make the moving average behave in many different ways. Sure, some people have a specific time frame and period that they use, but how is that better than another trader's time frame and period? To me, they are just different, not better. For this reason, I prefer to use analysis that will not change based on the time frame or number of candles counted (period). Plenty of traders have had success using these tools, of course, but I don't like the naturally subjectivity they can create. So let's say we analyze trend by the method I describe in the previous paragraph. It is fairly simple to identify the trend using this method. However, look at the example below. The time frames and currency pairs have not been listed. Before reading ahead, take a moment to look at the charts below and answer the following questions for each chart separately. They are not 2min Charts, but I had to give some time frame because the web design. So don't let that throw you off. Also, don't cheat by trying to look at your own charts or by reading ahead.
What is the direction of the trend?
What currency pair do you think this is?
What time frame do you think this is?
Would you be more likely buy or sell this pair?
Now that you have written down your answers written down, the results may surprise you. In fact, both pairs are the EUR/USD from about 6 months ago. Chart 1 is an 8hr Chart and Chart 2 is 1hr Chart. However, they look like opposites without identifying the currency pair or the scale. This is another reason why determining the trend is more difficult than it looks. Both trends are valid, right? Chart 1 is clearly a downtrend and Chart 2 is clearly an uptrend, right? Naturally, the answer is that multiple trends can occur on the same currency pair at the same time. Therefore, there is almost always no "one true trend". There are various trends based on the time frame that you look at. Naturally, the trend you put more weight on is determined by the time frame you trade on. If you are a swing trader, you probably would look at Chart 1 (the 8hr Chart). If you are a day trader, you probably would look at Chart 2 (the 1hr Chart). The point is, there is no way to identify the "one true trend", because there can be multiple trends.
Now, of course there are times when one trend seems more obvious, and I will even write about the most important trend at times (in my opinion, of course). However, the trend is more subjective than one might think at first. For another exercise, let's say that a currency pair has moved in an uptrend since it was established. There have been virtually no corrections down and the pair is currently shooting up on all time frames. First of all, this is rare in currencies, and more common in other financial instruments. Regardless, let's pretend our currency pair has been shooting up with no correction. Does this mean it will always go up? Probably not. It is very difficult to find an example of a major financial instrument that never sees a correction. And if it hasn't seen one yet, it probably will at some point. So even if you buy and the pair continues to rise, the trend will not save you when the pair inevitably plunges. So even if by some chance you are able to find this scenario, it doesn't assure you of great riches.
So what is the point? Obviously it can be useful to determine a potential trend. However, this is only part of the equation. I believe it is nearly impossible to have long term success by only trying to determine a trend. Even if you hopped on the right trend, how would you know when would exit the position? You need to have a plan beyond the trend, which is somewhat subjective to begin with. I believe that the trend you identify should be used a context in which to find trade opportunites. If you don't have a more detailed way to determine entries, how can you determine which time frame's trend to use? For instance, at FX360 we commonly use geometric patterns to determine our entries and exits. If we find one of these patterns within the context of a trend line or channel, this improves the odds of the trade's success. While this subject may not be revolutionary, I hope this article serves as a solid introduction to the reality behind using trends in your analysis.
In fact, on this very site I have seen multiple comments to my features that basically say "this is so complicated, all you have to do is follow the trend...trading is easy!" Needless to say, it isn't that simple. First, we must decide how to define an uptrend and a downtrend. The easiest way to do this, is by looking at a plain old chart. If there are consecutive lower lows and consecutive lower highs, that is a downtrend. If there are consecutive higher lows and consecutive higher highs, that is an uptrend. That part really is that simple. There are many tools available to help traders identify the trend though. Moving averages are among the most common.
The problem with moving averages is that they change when you change the chart. By changing the time frame of the chart and the number of periods factored in, you can make the moving average behave in many different ways. Sure, some people have a specific time frame and period that they use, but how is that better than another trader's time frame and period? To me, they are just different, not better. For this reason, I prefer to use analysis that will not change based on the time frame or number of candles counted (period). Plenty of traders have had success using these tools, of course, but I don't like the naturally subjectivity they can create. So let's say we analyze trend by the method I describe in the previous paragraph. It is fairly simple to identify the trend using this method. However, look at the example below. The time frames and currency pairs have not been listed. Before reading ahead, take a moment to look at the charts below and answer the following questions for each chart separately. They are not 2min Charts, but I had to give some time frame because the web design. So don't let that throw you off. Also, don't cheat by trying to look at your own charts or by reading ahead.
What is the direction of the trend?
What currency pair do you think this is?
What time frame do you think this is?
Would you be more likely buy or sell this pair?
Now that you have written down your answers written down, the results may surprise you. In fact, both pairs are the EUR/USD from about 6 months ago. Chart 1 is an 8hr Chart and Chart 2 is 1hr Chart. However, they look like opposites without identifying the currency pair or the scale. This is another reason why determining the trend is more difficult than it looks. Both trends are valid, right? Chart 1 is clearly a downtrend and Chart 2 is clearly an uptrend, right? Naturally, the answer is that multiple trends can occur on the same currency pair at the same time. Therefore, there is almost always no "one true trend". There are various trends based on the time frame that you look at. Naturally, the trend you put more weight on is determined by the time frame you trade on. If you are a swing trader, you probably would look at Chart 1 (the 8hr Chart). If you are a day trader, you probably would look at Chart 2 (the 1hr Chart). The point is, there is no way to identify the "one true trend", because there can be multiple trends.
Now, of course there are times when one trend seems more obvious, and I will even write about the most important trend at times (in my opinion, of course). However, the trend is more subjective than one might think at first. For another exercise, let's say that a currency pair has moved in an uptrend since it was established. There have been virtually no corrections down and the pair is currently shooting up on all time frames. First of all, this is rare in currencies, and more common in other financial instruments. Regardless, let's pretend our currency pair has been shooting up with no correction. Does this mean it will always go up? Probably not. It is very difficult to find an example of a major financial instrument that never sees a correction. And if it hasn't seen one yet, it probably will at some point. So even if you buy and the pair continues to rise, the trend will not save you when the pair inevitably plunges. So even if by some chance you are able to find this scenario, it doesn't assure you of great riches.
So what is the point? Obviously it can be useful to determine a potential trend. However, this is only part of the equation. I believe it is nearly impossible to have long term success by only trying to determine a trend. Even if you hopped on the right trend, how would you know when would exit the position? You need to have a plan beyond the trend, which is somewhat subjective to begin with. I believe that the trend you identify should be used a context in which to find trade opportunites. If you don't have a more detailed way to determine entries, how can you determine which time frame's trend to use? For instance, at FX360 we commonly use geometric patterns to determine our entries and exits. If we find one of these patterns within the context of a trend line or channel, this improves the odds of the trade's success. While this subject may not be revolutionary, I hope this article serves as a solid introduction to the reality behind using trends in your analysis.
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