Why do most traders follow the trend?
How to identify the current trend How
to draw trend lines on a chart
Financial markets are typically in one of three basic states: uptrend, downtrend, or range. Most traders follow the trend, but some traders also use countertrend and shifting market strategies.
Trend tracking is the most popular trading method because the markets move longer and further, allowing traders to set profit targets higher than stop losses, giving them a potential advantage even if most of their trades are losing.
Accurately determining the current state of a market is the key to making a profit.
Up and Down Trends
If an instrument is trending, you should only consider taking a position and trading in the direction of the trend. Ideally, you want to enter the position (long or short) at the best possible price to maximize your potential profit.
Some investors may expect a pullback (trend reversal caused by large institutional market participants using countertrend strategies or taking profits). Before you enter the market, however, you should know that no one knows for sure how long a trend will last and that eventually a reversal will turn into a trend reversal or a price consolidation where the markets begin to shift.
A strong uptrend (or bull market) can be identified by a series of higher highs and higher lows, while a strong downtrend (or bear market) can be identified by lower lows and lower highs.
This chart on Gold/USD CFD illustrates all these features:
How to Identify a Trend
Traditional technical analysis states that during an uptrend, you have higher highs because buyers are in the majority and pushing prices higher, and lows are higher because buyers continue to buy earlier bearish/retracement.
This is also true during a downtrend: the lows are lower as the volume of sellers drives prices down, the highs are lower as sellers continue to sell earlier rallies/retracements.
You can apply a trendline to your chart to help identify trends. This will also help you identify areas where pullbacks are likely to reverse, as usually shown in the chart below:
Markets are not always on clear trends. Markets, also known as lateral or range-bound markets, have periods of consolidation.
Markets change based on a variety of factors. They can result from times of low liquidity or when there is indecision between buyers and sellers and there is not enough consensus to move the market strongly in one direction. Buyers and sellers test each other, but no real consensus emerges. While some retail traders implement a range trading strategy, the majority will wait for a consensus to create and trade the resulting breakout.
This is shown in the chart below. The EUR/USD pair has been in the 76 pips range for over two and a half days. Finally the bulls stepped in and made a gain of almost 600 pips for the Euro!
Time Frames and Trends
It’s important to remember that timeframes in trading are fractal – the smaller the timeframe, the more detail you’ll see on the larger timeframes.
In the EURUSD range-linked market example we just reviewed, a swing trader might have identified the shifting market and waited for a possible breakout using the one-hour (H1) charts.
However, a trader using the fifteen-minute (M15) charts could see a few good ones to trade.
The beauty of modern trading is that we have access to many different instruments, in many different timeframes, and can easily search for trending instruments throughout the day.
Still, it’s important to learn about the different individual characteristics of each market traders should always abide by the rules of their trading systems and their trading objectives.