A common theme I notice in reviewing students’ trades is that most of their losing trades were taken in the hopes of catching a reversal in the trend. So they were trades opened in the opposite direction of the current trend. I’m not saying that those counter-trend trades will not work out. They will, but only with the right setup.
You need to understand the dynamics of a trend first. There are two distinct environments present in any trend. They are the Impulse and the Correction. We discuss these environments in much greater detail in our courses, but I will explain them here. The impulsive environment is the movement in the direction of the larger trend. These movements are typically large in price movement, but short in duration. Think of large candles covering lots of price. We want to trade the impulses as they offer the most potential reward with the least risk.
The corrections are pauses or retracements in the trend. They are usually caused by profit taking and also amateur traders trying to time tops and bottoms improperly. The corrections tend to consume more time than the preceding impulses and cover less price distance. We do not want to trade these corrections as risks are elevated compared to the small rewards we may receive.
So how do we know when the trend is ending and the impulses will reverse direction? Trends end at supply or demand of the larger time frame. We need proper perspective and must look for the larger warning signs. Imagine walking with your head down across your living room. You will proceed for a period of time in that direction (the impulse), but eventually end at supply (the wall). Trading is the same way. You stop impulses at the walls formed from larger time frames.
Look at the example; if you traded the long side of SBI stock in the morning, you profited with bigger moves in shorter periods of time. The short opportunities were not as easy to find and offered less potential for reward. That is until the market shifted. Notice how the moves to the downside began to equal the upward thrusts in price length at the bottom of the move. This is an indication of a possible reversal. The weak upward move midday after a bearish impulse warned traders that there may be a better shorting opportunity soon. This was just before the largest price move of the day which happened to be down.
So keep in mind the overall environment you are trading in. Are you trading with the larger trend? Is it about to hit the wall? Until next time, trade safe and trade well!