This article will help in identifying the presence, strength and direction of the trend.
The say, "A trend is a friend". One would extend it by saying "A trend is a friend, till it bends.".
Some traders, who are new to identifying trends or have still not perfected the art of following trends, would say "A trend is a friend, with a fickle and ever changing mood." If you find yourself to be one of these, then read on. This article will make it very simple for you to identify and benefit from trending markets.
So what is a trend ?
Everyone knows that the prices in any market, be it equity, Forex or commodities, keep on fluctuating tick by tick. This makes prices rise and fall. Each price point is the consensus of the entire market at that moment of time. But there are pressures from the by standers, which make the next price tick either go up or move down. These price actions come from so very different people, groups and organizations, also from so much variety of global locations, that they cannot be controlled by any one person or group or organization. Once, you have taken this phenomenon at face value, then you are ready to take that step towards, understanding the trend.
Bulls are people who take the prices up by buying more at higher prices. Bears are people who take the prices down by selling more at lower prices. There are times when Bulls become Bears and times when Bears become Bulls. These all are part of the forces that drive prices.
There are times, when the Bulls keep on taking the prices up by buying more and more at even higher prices. During these times, you will notice that the Day Highs are almost overcome with ease. Also you might notice that the Day Lows, stay intact for quite a considerable period of time. These are times when one can say a Bullish Trend persists in the market.
Conversely, when Bears keep on pushing the prices down by selling more at even lower prices, you will notice that the Day Lows are broken with ease and the Day Highs remain intact for a considerable period of time. These are times when you can say a Bearish Trend is present in the market.
So in a nutshell, it is the price action that determines whether a trend is present in the market and whether it is Bullish or Bearish.
A Bullish trend is identified by the ability of the Bulls to overcome Day Highs, consistently, without causing much harm to the Day lows.
A Bearish trend is identified by the ability of the Bears to breach Day Lows consistently, without causing much harm to the Day Highs.
Markets can remain trend less too :
If the Bulls are failing to consistently overcome Day Highs, or if the Day Lows are getting breached or tested while the Bulls are trying to overcome the day highs, then one can say the Market is trend less, or in other words, say it is "Sideways" or is "Consolidating".
A sideways or a consolidating market can be identified, by the inability of bears to breach day lows consistently, or by the ability of bulls to test day highs while the bears are trying to breach day lows.
It is difficult to trade such consolidating markets, and there are chances of your trades getting whipsawed quite intermittently.
Market trends can change :
Lastly, the market trends can and do change, and one needs to identify these changes else one may not only lose profits, but will be compelled to book heavy losses.
Identifying a changing trend is also easy if you watch the price action.
If the bulls fail to conquer a Day High after several tries in a bullish market, you should be ready for a trend change, and start booking profits in your long positions immediately. This change gets confirmed, if the Bears successfully breach the Day low. You could then possibly look out for going short, depending on your trading style and appetite.
Similarly in a bearish trending market, the bears need to keep on breaching the day lows. If they fail after several tries, then you should sense a trend change and should book out of your short positions immediately.
Technical tools for trend identification :
There are many technical tools available for trend identification including moving averages (both simple and exponential), RSI, MACD, Stochastics, etc.
However, we find that the best trend identification is done by the ADX and a small discussion about reading and trading the ADX is imperative here.
Understanding the ADX :
The ADX ( Average Directional Index ) was introduced by Welles Wilder about 5 decades ago, and is still applicable to current markets as well.
The ADX comprises of three components , the +DX, the -DX and the ADX. The +DX represents the ability of the Bulls to raise prices higher and higher. The -DX represents the ability of the Bears to push prices lower and lower. The ADX represents a smoothed average of both the +DX and the -DX.
Constructing the ADX is a complex calculation, and we won't go discussing that in this article. For those who are interested in building your own ADX system, you can refer to this article.
Using ADX for trend identification and trading :
There could be multiple scenarios being played out in the market. We will look at each of them one by one.
Scenario 1
The ADX is rising and the +DX is higher than the -DX. This clearly indicates a bullish trend getting stronger. Trade only on the long side. Look out for prices retracing till Day averages, or near the high EMAs to initiate long positions. Keep on trailing your stop losses to preserve profits.
Scenario 2
The ADX is rising and the -DX is higher than the +DX. This is a clear case of a bearish trend getting stronger. Trade only on the short side. Look out for prices retracing till the Day averages or near the lower EMAs to initiate short positions and trail your stop losses once you are in trade, to preserve your profits.
Scenario 3
The ADX is falling and the +DX is higher than the -DX. Clear time to book profits in your long positions and await for the next signal on the ADX. Refrain from opening short positions or reversing your trades at this point of time.
Scenario 4
The ADX is falling and the -DX is higher than the +DX. Clear time to book out of your short positions and await for the next signal. Refrain from reversing your trades or opening fresh long positions at this point of time.
Scenario 5
The ADX is below the +DX and the -DX. This is a clear indication of a trend less market, and you should avoid trading if you are not a seasoned trader. If you are a seasoned trader, you should be ready to trade on both sides using overbought oversold oscillators like the RSI or the stochastics in conjunction with the ADX. Your bias should be towards the Bulls if the +DX is higher or towards the Bears if the -DX is higher.
We as a thumb-rule consider the market to be strongly trending if the ADX is above 25. Between 20 and 25 we consider the ADX to be indicating that a baby trend is being born. Below 20, we consider that the market is sideways or consolidating. Above 55, we take cautious approach in following the current trend, and tighten our stop losses.
Hope this small article will help you simplify trading following trends. It may also help you in not to search for a trend when none is present in the market.
Happy Trading !!!
The say, "A trend is a friend". One would extend it by saying "A trend is a friend, till it bends.".
Some traders, who are new to identifying trends or have still not perfected the art of following trends, would say "A trend is a friend, with a fickle and ever changing mood." If you find yourself to be one of these, then read on. This article will make it very simple for you to identify and benefit from trending markets.
So what is a trend ?
Everyone knows that the prices in any market, be it equity, Forex or commodities, keep on fluctuating tick by tick. This makes prices rise and fall. Each price point is the consensus of the entire market at that moment of time. But there are pressures from the by standers, which make the next price tick either go up or move down. These price actions come from so very different people, groups and organizations, also from so much variety of global locations, that they cannot be controlled by any one person or group or organization. Once, you have taken this phenomenon at face value, then you are ready to take that step towards, understanding the trend.
Bulls are people who take the prices up by buying more at higher prices. Bears are people who take the prices down by selling more at lower prices. There are times when Bulls become Bears and times when Bears become Bulls. These all are part of the forces that drive prices.
There are times, when the Bulls keep on taking the prices up by buying more and more at even higher prices. During these times, you will notice that the Day Highs are almost overcome with ease. Also you might notice that the Day Lows, stay intact for quite a considerable period of time. These are times when one can say a Bullish Trend persists in the market.
Conversely, when Bears keep on pushing the prices down by selling more at even lower prices, you will notice that the Day Lows are broken with ease and the Day Highs remain intact for a considerable period of time. These are times when you can say a Bearish Trend is present in the market.
So in a nutshell, it is the price action that determines whether a trend is present in the market and whether it is Bullish or Bearish.
A Bullish trend is identified by the ability of the Bulls to overcome Day Highs, consistently, without causing much harm to the Day lows.
A Bearish trend is identified by the ability of the Bears to breach Day Lows consistently, without causing much harm to the Day Highs.
Markets can remain trend less too :
If the Bulls are failing to consistently overcome Day Highs, or if the Day Lows are getting breached or tested while the Bulls are trying to overcome the day highs, then one can say the Market is trend less, or in other words, say it is "Sideways" or is "Consolidating".
A sideways or a consolidating market can be identified, by the inability of bears to breach day lows consistently, or by the ability of bulls to test day highs while the bears are trying to breach day lows.
It is difficult to trade such consolidating markets, and there are chances of your trades getting whipsawed quite intermittently.
Market trends can change :
Lastly, the market trends can and do change, and one needs to identify these changes else one may not only lose profits, but will be compelled to book heavy losses.
Identifying a changing trend is also easy if you watch the price action.
If the bulls fail to conquer a Day High after several tries in a bullish market, you should be ready for a trend change, and start booking profits in your long positions immediately. This change gets confirmed, if the Bears successfully breach the Day low. You could then possibly look out for going short, depending on your trading style and appetite.
Similarly in a bearish trending market, the bears need to keep on breaching the day lows. If they fail after several tries, then you should sense a trend change and should book out of your short positions immediately.
Technical tools for trend identification :
There are many technical tools available for trend identification including moving averages (both simple and exponential), RSI, MACD, Stochastics, etc.
However, we find that the best trend identification is done by the ADX and a small discussion about reading and trading the ADX is imperative here.
Understanding the ADX :
The ADX ( Average Directional Index ) was introduced by Welles Wilder about 5 decades ago, and is still applicable to current markets as well.
The ADX comprises of three components , the +DX, the -DX and the ADX. The +DX represents the ability of the Bulls to raise prices higher and higher. The -DX represents the ability of the Bears to push prices lower and lower. The ADX represents a smoothed average of both the +DX and the -DX.
Constructing the ADX is a complex calculation, and we won't go discussing that in this article. For those who are interested in building your own ADX system, you can refer to this article.
Using ADX for trend identification and trading :
There could be multiple scenarios being played out in the market. We will look at each of them one by one.
Scenario 1
The ADX is rising and the +DX is higher than the -DX. This clearly indicates a bullish trend getting stronger. Trade only on the long side. Look out for prices retracing till Day averages, or near the high EMAs to initiate long positions. Keep on trailing your stop losses to preserve profits.
Scenario 2
The ADX is rising and the -DX is higher than the +DX. This is a clear case of a bearish trend getting stronger. Trade only on the short side. Look out for prices retracing till the Day averages or near the lower EMAs to initiate short positions and trail your stop losses once you are in trade, to preserve your profits.
Scenario 3
The ADX is falling and the +DX is higher than the -DX. Clear time to book profits in your long positions and await for the next signal on the ADX. Refrain from opening short positions or reversing your trades at this point of time.
Scenario 4
The ADX is falling and the -DX is higher than the +DX. Clear time to book out of your short positions and await for the next signal. Refrain from reversing your trades or opening fresh long positions at this point of time.
Scenario 5
The ADX is below the +DX and the -DX. This is a clear indication of a trend less market, and you should avoid trading if you are not a seasoned trader. If you are a seasoned trader, you should be ready to trade on both sides using overbought oversold oscillators like the RSI or the stochastics in conjunction with the ADX. Your bias should be towards the Bulls if the +DX is higher or towards the Bears if the -DX is higher.
We as a thumb-rule consider the market to be strongly trending if the ADX is above 25. Between 20 and 25 we consider the ADX to be indicating that a baby trend is being born. Below 20, we consider that the market is sideways or consolidating. Above 55, we take cautious approach in following the current trend, and tighten our stop losses.
Hope this small article will help you simplify trading following trends. It may also help you in not to search for a trend when none is present in the market.
Happy Trading !!!
I read your article on ADX.Kindly clarify for nifty trading,which chart to be used for ADX ,5 min,15 min,30 min,60 min ,4 hour or daily chart.waiting fo you reply.
ReplyDeleteDear J L Bansal,
DeleteUsing multiple time frames for trend identification is a highly recommended method to initiate sustain and terminate trading positions. However, selection of a particular set of time frames is highly dependent on your trading and risk management aptitude.
In a lower time frame, you get to know the trend change pretty early. However, on the flip side, you miss out on major moves and get whipsawed quite frequently.
On a higher time frame, the amount of patience required increases exponentially. Also on a higher time frame you need to have a larger stop loss to avoid whipsaws.
Keep this in mind before choosing your time frame.
At itrade4profit, we use the hourly daily and weekly charts for trend identification. We use a strict SL of 25 to 35 points too.
Check out if this suits your trading style.
Thanx for reply.Kindly send me details of your subscription.
ReplyDelete