The most-traded state of the market is the trends. A Trend is that state of the market which gives a clear understanding of the direction of the market. On this article, we well discuss the properties of trends and how to trade them from a price-action perspective.
A basic tendency of a trend is that, when the market moves in one direction, it pulls back every step of the way and then continues its move. This phase of the trending market is called the pullback phase. And, during this pullback phase, we anticipate a trend continuation trade.
Unlike ranges and channels, where both parties are strong; in a trend, either the buyers or the sellers are dominant.
What is a trend?
A trend is one of the states of the market where the price moves in a particular direction by making higher highs (HH) & higher lows (HL) or lower highs (LH) & lower lows (LL). In an elaborated way, in a trend, the price makes an HH or LL, pulls back, holds above the Support and Resistance (S&R), and continues its move by making new HH or LL.
What is a higher high (HH) higher low (HL) and a lower high (LH) lower low (LL)?
There are two types of trends in the market:
An uptrend is the type of trend where the price makes higher highs and higher lows. Let us understand what does this means by an example given below.
In the above figure, we can see that the market begins its up move from point 1, stops at point 2, and pulls back until point 3. From point 3, the market breaks above point 2 and makes a new high (point 4). This phase of the market where the price makes a new high is called a higher high. Moving forward; after the market reaches point 4, it drops down to point 5. And, we can see that the market holds above the previous low (point 3). Hence, point 5 is referred to as a higher low. Therefore, all of it put together is called an uptrend.
When the market makes lower high and lower low sequences, it is called a downtrend. It is opposite of an uptrend.
Consider the below example. The market began to move down from point 1, made a low point 2, pulled back to point 3, broke down below the point 2 low and created a brand new low (point 4). Here, we can see that the new low of the market is lower than the previous low. Hence, it is called a lower low. Later, from point 4, the market pulled back again until point 5, which is lower than the previous high (point 3). So, this point is called a lower high. Hence, this structure of the market is called a downtrend.
How to identify a genuine trend
Note that, all markets facing upwards or downwards cannot be considered as an uptrend or a downtrend respectively. There are certain factors to consider before confirming that the market is in trending. The factors are as follows:
Support and Resistance
Considering the above example, point 2, 3, 4, and 5 represent the support and resistance areas. So, to consider the market as a trend, the mentioned four S&R must be strong. If the market breaks an insignificant S&R, it cannot be viewed as a trend. In the below figure, we can see that the market was hovering inside the box for a significant amount of time, which means that both buyers and sellers are pretty strong. Later, the buyers broke the above the resistance and made a higher high. Now, since the buyers broke above a strong resistance level and held above, we can call it an uptrend. As a result, we can also see that the market shot up after coming down to the S&R level.
If we consider the next example below, should we consider it as a real break in the market? No, as the pullback was very feeble, we cannot consider it as a real S&R, and cannot say that the market made a lower low.
Real HH or LL
Another important criterion is to determine if the higher high or lower low made by the market was real or not. Let us understand it with a couple of examples.
Considering the below example, the market was initially holding below the orange resistance. Later, the market breached above the resistance. Do we call this a real higher high? Well, we cannot consider it as a higher high, because the market did not hold above the resistance for a significant amount of time.
Now, let’s consider the below figure. When the market broke below the support (orange line), we can see that the price held below the orange line for quite a long time. Also, when the price pulled back until the support line, the sellers hit it for a sell again, confirming that the low the market made was real.
How to trade a Trend
Below is an example of how a price action trader handles a trend.
In the below chart we can see that the market was held at the support for quite some time. Later, the sellers picked up the pace, broke below the support and made a brand new low. Now, since the market is in a strong downtrend, we need to look for opportunities to go short. Also, as the price is too low at the moment, we wait for a discount (pullback) before we can hit the sell.
Considering the below chart, the pullback starts to kick in, and we can observe that it is pretty weak. Note that, if the pullback is slow and weak, there is a high probability that a sell order is going to work in our favour.
Now, to read the pullback, we analyse the market in a buyer’s perspective. We can see that the buyers, who were holding below the orange dotted resistance, finally broke above it and made a higher high. The sellers come down until the dotted S&R line, and the buyers hit it for a buy yet again. But, this time, the market did not make a higher high. It got shot down by the sellers aggressively.
Now, observe where this s scenario happened. Well, it happened at the seller’s S&R (orange line). This indicates that the sellers are back in the game. Also, the next time, when the price came to the dotted S&R line, the buyers could not even go as high as the previous high. This fact confirms that the buyers are entirely dead, and the sellers are fully active. Therefore, we can hit the sell anywhere around the orange dotted line without any fear or risk in mind.
We have seen above the price-action way to approach to read the market. Now, what do you think about how other traders would be looking at this market?
Other traders would be seeing it as an uptrend and would be thinking that the market will hold above the dotted S&R. So, when the price comes back to that region, they are willing to hit the buy button.
While we, on the other hand, are hitting the sell at the same position. So, basically we are selling it to them, and they are buying it from us. Hence, this is where all the money is made in the market. Also, this is the reason the stats indicate that 95% of traders are losing and only 5% winning.