Areas of market consolidation near the resistance and support levels and how to use them in trade.
How to ride a trend?
When a beginner trader is looking for information how to start trading with profit, he/she usually comes across an advice to follow a trend. If the currency pair is rising, it’s necessary to buy. If it’s falling, the recommendation is to sell. Indeed, there’s much sense in this recommendation. Yet, when it comes to practice, it becomes clear that everything is not so simple. To profit from trend trading, you will need more detailed instructions. This article will guide you through trend trading strategies and will give you a number of steps to make.
There are different trends
Before you start opening trades in MetaTrader, you need to know that there are 3 types of trends in terms of time:
- Long-term or primary trends
- Medium-term or intermediate trends
- Short-term trends
When traders ask us “What trend is there on the EUR/USD chart?” we usually ask “Which timeframe do you mean?” Indeed, if you check different timeframes for EUR/USD, the charts you will see may differ a lot.
Long-term trends may last for 8 months – 2 years. They show the bigger picture and reflect the difference in economic strength of the countries the currencies of which form a currency pair, for example, the euro area and the United States. Intermediate trends last for 1-8 months. They are formed within the primary long-term trends in the opposite direction. Short-term trends can last for several days and up to a month. They appear because of global capital flows caused by economic and political news. Such trends allow traders to make profit during a few hours.
It’s necessary to remember that even if you trade only during the day, you need to know not only the short-term but also the long-term and medium-term trends and draw their trend lines. Sometimes the price can meet resistance or support of a bigger trend. If you identify all three types of trends on your chart, you will have a better view of the market.
Stages of a trend
The next important thing is that every trend consists of 4 stages:
- Young trend
- Mature trend
- Aging trend
- Reversing trend
If a trend is already old, there’s no point in trying to trade it. The goal is to catch a trend at its beginning or during the early stage of its maturity. This way you will be able to get a good profit from trading the trend.
So, you should be looking for stage 2. At this point, you will be able to draw trend lines. For an uptrend, you will need at least 2 lows – the initial low and the higher low. If you have 3 lows to connect that’s even better – it would mean that a trend has really formed. The trend line will be a support line. For a downtrend, you will need at least 2 highs – the first high and the second, lower high. The same thing: it would be even better to connect 3 highs. In this case, the trend line will be a resistance line.
It’s very important that you don’t get lazy and make effort to draw the trend lines. They represent a simple but efficient tool of chart analysis. Not only will they help to find the areas where in future the price may bounce from support or resistance, but they will also show how strong a trend is. Go with this observation: the steeper the trend line, the bigger the chance that it will be broken by the price. If the price moves rapidly up, buyers who push it higher will soon run out of strength, and the market will reverse. If you want to pick a good trend that will last for a considerable time, choose the one with less steep trend lines.
We also advise you to look at the corrections and consolidations that take place during your trends. As you can see, even when the price has a tendency to move up or down, it doesn’t go straight up or straight down all the time. A correction is when a currency pair pulls back in the direction opposite to that of the main trend. A consolidation is a period of a horizontal movement of the price.
If the periods of counter-trend movement (corrections) are short and sideways ranges (consolidations) are narrow, you have found a solid strong trend and are safe to trade it.
There’s a group of indicators in MT4 which are called “Trend indicators”. They can help you to ride a trend.
Moving Average will help to identify an uptrend or a downtrend and act as support and resistance. We recommend using simple moving averages with periods of 20, 50, 100 and 200.
ADX shows the direction and the strength of a trend. Readings above 30 indicate a strong trend. Note that this indicator can be slow.
Traders can also use oscillators (indicators which oscillate around some central value and are shown in a separate window below the price chart). After you have determined the direction of the trend using trend lines or moving averages, check Stochastic oscillator. In an uptrend, its slope should be strongly up. In a downtrend, the Stochastic has to slope strongly down. If the price is making new highs in an uptrend, but Stochastic is not, it may signal a reversal down.
You can get similar data to those provided by the Stochastic indicator from another oscillator called MACD. The difference is that MACD comes in form of a histogram (columns below the price chart). During an uptrend, MACD columns should become bigger, while during a downtrend they should decline and then get to the negative area.
A strategy for trading using a trend
The best way is to go along with the market. Here are the recommended steps:
- Determine for how long you want to stay in the trend. This decision will influence the timeframes you choose for trading. If you decided to trade intraday (i.e. for up several hours only), determine the trend on the daily timeframe. You can also use H4 and H1 charts for planning your trade. We don’t recommend wasting time on smaller timeframes like M15 as the situation there changes too fast and it’s hard to make good analysis for a trade that will be open for several hours.
- Identify the trend – is it an uptrend of a downtrend? Check economic news and analytics, try to understand which fundamental (economic) factors or news stand behind this trend. Can it be that the market is anticipating an important event? Or maybe something has already happened and this is having an impact on the market? If the market sentiment is bullish, then you can buy in an uptrend. If it’s bearish, you can sell in a downtrend.
- Draw trend lines. Are they steep or normal? How many times did the price test the trend line? If the price touched the support line for the third time in an uptrend and pulled back up during an uptrend, it’s a signal to buy.
- Check technical indicators. Make sure that they confirm the trend.
- Determine the stage of a trend. Trading at the very beginning or at the end of the trend is risky, so it’s better to pick a nice mature trend.
- Put a limit order near a trend line. In an uptrend, place a Buy Limit at the support line. In a downtrend, place a Sell Limit near the resistance line.
- Place a protective Stop Loss on the other side of a trend line. Your Stop Loss shouldn’t be too tight so that you order doesn’t close simply because of the daily volatility. There’s no universal solution for choosing a Stop Loss. Much will depend on how long you aim to hold your trade (you need to have an idea where you will close your trade with profit) and on your trade size. Usually Stop Loss is about 1/3 of the potential Take Profit. All in all, for an intraday trade that lasts for several hours it is better to have a Stop Loss that exceeds 15 pips.