Last updated on July 4th, 2020
Trading with the trend is a simple concept where you only take trades in the direction of the price trend direction on your time frame.
If the trend goes up, you would only consider long trades. A market direction that is trending down, you’d only consider short trades. These are trading positions that should encounter less push back as opposed to always picking the top or bottom of the market.
Markets not only move up and down, but also in a sideways trend that is better known as a trading range.
The key is to know how to identify the trend which we do via a trend indicator or reading price action and structure.
Markets Trend and Range – Stages of Market Movement
Considering there are three stages to the market, we should know what we are looking for.
You can see smooth trending action to the upside on this chart in which case you’d be long. A range bound market hits and then we see a breakout to the downside.
Is that a change of trend direction where you’d only consider shorts? It depends and we will get to that.
Price trends up, range, and we head up again. Trading with the trend means trading with the main direction of price.
Trading with the trend would have you long and depending on how you measure trend, you’d either hold or exit at the ranges.
How To Identify The Trend Direction
How you measure the trend is less important than you being consistent in your method. It is far too easy to determine the trend and then, when the market changes direction, overriding your trading plan to catch the move.
Moving Average Method To Trading With The Trend
This is the most objective way to determine the trend in Forex, Futures, and even the stock market. It does come with an issue that trading indicators face and that is lag.
Lag is when the market has changed direction but the indicator is still on the prior trend.
You must also consider the moving average setting:
- A short term moving average would have you trading with the trend on a shorter term basis. A 10 period SMA would react earlier to price moves than a 200 SMA
- A longer term average may have you sitting through draw down (when your trade is losing money), depending on your exit strategy, before changing trend direction
- There are several types of moving averages to consider: WMA, SMA, EMA, Displaced
Using a moving average for trend direction will also include how you read it.
- Are you using the slope of the moving average for trend direction?
- Do you need price to break through the average?
- Is a breakout pullback to the average needed?
There is no best way to determine the trend with moving averages. Just find what you are comfortable with because you are not picking tops or bottoms.
The moving average will also show you when there is not an uptrend or a downtrend you can trade.
When price is churning around the moving average, we are looking at a range bound market. Using the 50 EMA closing price calculation as an example, once those closing prices are not finding momentum away from each other, the average closing price from one day to the next shows minimal difference.
This allows the moving average to catch up to the price bars. This is also what gives the illusion that moving averages provide support and resistance. You could use the average as a non-trending market indicator as well.
Trading With The Trend Via Price Structure
Price action on a chart leaves clues in the form of structures. Consider the range bound market above, price action resulted in similar highs and lows which constitutes a range.
We define a trend in this manner:
- Price that is making a series of higher highs and higher lows is considered an uptrend
- Down trending markets consist of price making lower highs and lower lows
- When structure is violated, I consider a range is beginning
This stock chart has a mixture of three different trends: sideways, up, and down trend.
You will want to have some general rules in how you interpret the charts: when the trend changes, when you determine there is sideways movement.
Using this chart as an example:
- Support and resistance are zones and if price makes a high or low in the same general area, I call them equal and consider a range
- If price, as in this example, makes a LH but a HL, that is still a range
- Price breaking out can be the first sign of a trend change. HH must be followed by a higher low. Some traders will wait until the HL is confirmed by a break of the high
- Price drops through with momentum a HL and with the LH put in, we have a defined down trend
- Price will make breaks through highs and lows but you must determine if the break is a legitimate change of trend
Looking for price activity after a break of swing highs and lows to confirm there is a change.
Trendlines To Trade In The Trend Direction
How to draw trendlines can be subjective so having rules to follow when drawing them is vital. The general rule is fanning trendlines so the line doesn’t cut through current price.
My additional rule is I must be able to capture the last swing low into the high.
Remember you need at least two swing levels to draw a trend line. Here is a breakdown of what is on this chart:
- The main trend line and the “line in the sand for trend change
- The second point for this trend line is the final high before a new low. I draw this because the first one would cut through price
- We start to fan trend lines here due to the slope of the emerging trend. Keep in mind there was no price after this when this line was drawn
- Same anchor point at low but new higher swing low
- Final trend line into the high
- The main trend line
The purpose of the line connecting the final low into highs is an early warning of trend change. It can also set up a trading with the trend type of setup that won’t be covered here.
The key point is a break of the trend line shows that something has changed with the rhythm of the trend. This is even more important when the break is accompanied by momentum. There is no best momentum indicator to help you judge the strength but I find certain candlestick patterns helpful.
Trading With The Higher Trend
There are as many trends as there are time frames. A downtrend on a one hour chart could simply be a pullback on a four hour chart.
Why do traders look to trade with the trend of the higher time frame? The logic is the higher time frame exerts more power on the lower time frame.
Keep in mind though that a higher time frame trends can only start when the lower time frames turn direction.
Understanding that, there are two main trend determination tools, along with the ones already mentioned, that can be used on the higher time frame.
MACD For Trading With Trend Of Higher Timeframe
The first one is the MACD but with the settings used by Joe Dinapoli, 8 – 17 – 9. This is the daily chart with the weekly MACD on the bottom.
The general rule is to trade in the direction of the cross of the MACD/signal line using your trading strategy.
The histogram is also something to watch for. In this example, the rising histogram is showing downside momentum is fading. Traders can use the rising histogram along with price to start trading in the emerging trend direction. I find that trading the breakout with this method is a decent approach.
In our chart example, you can see the histogram rise along with a higher low put in which points to further trending upside.
This is just one of the many MACD trading techniques that traders can use to improve their trading.
Displaced Moving Averages
This example uses moving averages but with a twist. Displaced moving averages are used in the trading indicator known as the “Alligator” and simply displace forward the plotting of the average.
In our example, we are using the 6 period setting of the high and low price displaced 4 periods. This is a daily chart example and either the weekly or the monthly chart for the trend direction you will trade.
When price closes below or above the averages, you will trade that direction on the lower time frame. What you do when price enters the space between the two displaced averages will depend on your trading plan.
You can also use price structure in combination with this method. As an example, the middle of the chart shows a break to the downside and then back to the upside. On the daily chart, you would notice a double bottom as been put in which would alert you to a potential trend reversal.
Trading with the trend is trading in the main price direction. You can determine trend different ways as well as a conservative or aggressive approach.
- Waiting for the MACD cross, for example, is conservative due to the confirmation aspect
- Watching the histogram rise along with price action is aggressive
There are many ways to determine the trend and the key is to stick to one that fits your trading style. Looking for the best trend indicator is a waste of time that could be better served adjusting and perfecting your trading rules including placing your stop loss when entering your position.
Using volume and price to determine trend direction is viable and the Klinger Volume Oscillator is a good place to start.
If you want to learn about price patterns that you can use in conjunction with trend, please download our free guide to “Trading With Price Patterns“. The feedback to this free trading resource has been phenomenal.