Know your Trends Course

Chris L
Category:  Trading Courses

Chapter 1: Introduction to Trends
For beginner traders, the financial markets often appear chaotic and confusing. But underneath all that seemingly random movements, there is a sound logic to explain why the markets move the way they move. Generally, the price movements in the financial markets are governed by demand and supply. As supply goes up, with demand being constant, this will push prices down. And if demand increases with supply being constant, the additional demand will exert an upward pressure on prices. However, sometimes a trader may not understand why the markets does not behave as it is supposed to be as dictated by the laws of demand and supply. In order for a trader to be effective, he must understand how demand and supply be interpreted different under differing market scenarios.
 
Only by fully understanding how to arrive at these different interpretations can a trader take advantage of all the trading opportunities presented by the markets. One way of understanding different market analysis is by looking at trend trading. Trending markets can help you immensely by understanding about the flow in the market and increases your awareness about market timing. Trend trading is essentially a trading strategy which aims to capitalize on market gains based on the analysis of an asset’s market momentum while moving in a particular direction.
 
When trading trends, the strategy assume that the price movements of an asset will continue in the same direction for the future. It add an element of certainty in an uncertain market and this is why many experienced traders use it as their main trading strategy for the short term, medium term and long term. Hence, a trader can essentially remain with his market position until he believes that the trend will reverse soon or has reversed. However, when the reversal has occurred will depend on the time frame of the price chart that the trader is using.


Chapter 2: Trend Lines (Channel) Construction
To begin your trend analysis, you need to first construct the trend channel on your price chart. There are a number of reasons for drawing these trend lines on your chart:
 
  • To Indicate the Trend Direction
If we were to look at any price charts, we will be able to see that the markets are constantly moving up and down. However, there are times when the markets will tend to move more in one general direction. It is this directional movement that we are referring to as “trend” in the context of financial trading. At the same time, we will also see a lot of random movements in the market which are often referred to as “noise”. To help filter the “noise” in the market and see the trend more clearly, we use trend lines on our price charts.
 
  • To identify potential support and resistance points
Another use of trend lines is to establish possible points of resistance and support. While prices in the markets are constantly moving up and down, there will be occasions where these movements will touch these trend lines and then rebound. The rebounds often tend to be concentrated within a specific region.



 
  • For Identifying Breakouts
Any strong moves upwards or downwards to outside the trend channel often precede a reversal of the trend or a decline in the momentum of the price movements. By knowing this information, a trader is better poised to plan his next course of action.
 
When constructing a trend channel, ensure that you pick:
 
  • 2 low points and one high point for an uptrending market
  • 2 high points and one low point for a downtrending market
 

 
Chapter 3: Bottoms & Tops
When analyzing your price charts, it is important to take note of the highs and lows of the trend channel. This is because these points have their respective significance. For charts which illustrate consecutively higher bottoms, that is when each key low point is higher that the preceding low point, they signify a trend with a medium term strength.


Where the lows of each candlestick of a daily chart are higher than the preceding candlestick, this signifies a trend with short term strength. This scenario also indicates that institutional investors are supporting the price movements in the market. On the other hand if the price chart is illustrating consecutive lower highs where each key high point is lower than the one before it, this signifies a trend with medium term strength.


In the case of a daily chart where the lows of each candlestick are lower than the one before it, this signifies a trend with short term strength. It also implies that institutional investors are not supporting the move.
 
Key Notes:
  • The first indication of a possible change in the direction of the trend is when you get the first lower top in bullish market or when you get the first higher low in a bearish market.
  • Trend lines should not be interpreted in a strict sense but rather to act a gauge of the market trend.
  • When analyzing trends on a price chart, always compare them in 2 different timeframes, for example between a short term and a medium timeframe charts.
  • It is important to bear in mind that trend lines indicate potential resistance to a price movement. In order for prices to penetrate this resistance, it requires significant effort as well as the intervention of intuitional investors. Study the trading volume as the price approaches this resistance level. The lack of effort or existence when the price is around these resistance areas will provide you with an idea of the trend line will hold or not.
 
Chapter 4: Trend Scaling
Trends at first glance often don’t reveal the whole picture of the market. This is due to the fact that their scale depends on your point of observation. A good analogy of this phenomenon is to compare the views of the coastline of Western Europe. From a satellite image viewpoint, the entire coastline of Western Europe appears jagged. As we view the coastline from an aircraft, the coastline will still appear jagged. It is only when we stand on the beach on the coastline will we be able to say that the coastline appears wavy and not jagged. The same principle applies when we look at our price charts with different timeframes.
 
The trends on our price charts can be viewed from 3 different perspectives:
 
  • Long Term
  • Medium Term
  • Short Term
 
When viewing the charts from a short term perspective, we are essentially looking at minor trends. With medium term charts, we are more concerned with intermediate trends. If we are only interested in a major or primary trend, we will then scaling our charts to view it from a long term perspective.
 
On a broader scale, all trends contain within them minors trends as well as counter trends. To view them, all it takes is for us to scale down the timeframe of the price charts all the way down to a single tick price movement if our analysis requires it. However for most traders, it is the intermediate trend that is most frequently used. Then again we should remember that an intermediate trend is only just a matter of scale. For example, a short term trend on a weekly scale can be considered an intermediate trend if we view it on a daily chart. And if to shorten the scale to an hourly chart, it becomes a long term trend.
 
Why Trend Lines Works
While there is no mathematical proof that trend lines works, visual observations of the behavior of these trend lines do suggest they act as support and resistance levels. For example, if we were to take a chart with a 50 period moving average (MA), we will notice that while there are occasions where the line is fairly straight, there is still a noticeable trend in the way prices are moving.

While the daily prices may be fluctuating up and down producing mean a mean loss or gain around the MA, we can still see the trend clearly. This helps to explain why when we often hear that the unemployment figure is up but still observe that the underlying trend is still down.
 
Another characteristic about trending data which shows a mean loss or gain is the tendency for prices to return towards the mean. We often hear of this as a rebound. For example if prices experienced a sharp rally and moves beyond the mean gain slope, this is often followed by a pullback of prices back towards the mean slope and below it to compensate for the price rally earlier. When a market is rising, it is also losing equilibrium. Pull backs follow rallies as a reaction to restore temporary equilibrium. This is why we often see trends exhibiting the familiar jagged saw edge movements due to the imbalance between supply and demand of the underlying asset. For a persistent bullish market, there can also be periods of congestion as this is also another which the market tries to restore equilibrium.
 
If your trend lines are constructed correctly, you can easily see prices oscillating in between the trend channel. As we have mentioned earlier, trend lines seems to act as a resistance level and this is why we see prices oscillating between the trend lines. If a trend line happens to be breached, it will act as the new resistance level but from the opposite direction.

Note that the resistance level becomes a new support level after penetration
 

Chapter 5 Determining Overbought & Oversold Levels with trends lines
So far we have learn that prices typically oscillate between the upper and lower trend lines. The area which prices are trading is known as the trading range. The trading range is applicable to all types of trending markets regardless of whether it is trending upwards, downwards or sideways. However traders often refer to a sideways trending market as a ranging market. So if you come across ranging market, it could mean that the market is trading between the upper and lower trend lines or it could also mean that the market is trending sideways. Regardless of the context which the term “trading range” is being used, what is important to remember is that prices trading within the range can penetrate the trend lines and if the trading momentum holds, the breakout can signify a change in the trend. 
 
Trend lines can also be used to determine “overbought” or “oversold” market conditions. An overbought market condition is when demand exceeds supply creating an upward pressure on prices. On the trend lines, this is indicated by prices trading in the region just above the upper trend line. An oversold market condition is when supply exceeds demand creating a downward pressure on prices. We can see this happening if prices are trading in the region just below the lower trend line
 

When you get prices trading within the overbought or oversold regions, the likelihood of a price reversal increases. But note that it is not a foregone conclusion that a reversal will as we mentioned earlier that prices tend to pull back after a rally as the market to restore equilibrium. But if the trading momentum maintains its strength after the breakout and the market has been moving on a downtrend, the old resistance level will become the new support level. And if the market has been on the uptrend, the lower trend line will end up being the new resistance level.
 

 
Conclusion
To beginner traders, the market may seem random and chaotic. But if we take the effort to understand the underlying reason the price movements in the markets, there is actually order and an element of predictability in the way the financial markets behave. And once we understand the principles behind the way the markets move, it becomes easier to follow the developments in the market. It is only through this understanding of the ways the markets moves that we will be able to create winning trading strategies.
 
 
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