Lessons from the Pros


Playing the Probabilities in Forex Trading – Part 2

Firstly, I would like to say a big thanks for your feedback from last week’s article on currency price. I am glad you enjoyed it and I’m happy that many of you found it useful. As promised, this week we continue the discussion in the second part of the series, this time with a distinct focus on the concept of trend trading.

Free Trading WorkshopPretty much every student I meet within Online Trading Academy has at some point read or viewed information on how the markets work before coming to us for help. They decide to join us because they feel that there is still something missing from the limited education they obtained from trading books or the internet. If you ask the majority their opinion on trend trading they say that they, heard “The trend is your friend” and you should always look to follow it when trading any asset class. Then ask them how much of a friend the trend has been to them on a consistent basis and typically, they will say not very often. Obviously this concept warrants further discussion.

Let’s be clear right now, I am not suggesting that trend trading is a waste of time in any manner. The issue we have with trading in this style is simply that traders are often late to the game when following trends. They end up trying to follow a dominant direction in the market which they can clearly see, yet they get stopped out and then watch the market go the way they were expecting. In my experience, trend-trading can be great, but it also requires patience to wait for a solid entry which allows a decent risk to reward ratio. Think about this for a second: when you trade a trend you are jumping on board a move which has already been happening for a decent amount of time, hoping that it will continue in that direction. By nature you are always late to the move when you do this, putting yourself in a situation where you are buying after everyone else has bought or selling after the masses have already sold. Nobody wants to enter the market late and be the entry which closes somebody else’s profitable trade, do they? In any kind of trend trading, this is always a risk to be aware of.

So, what is a smart way to approach trend-trading? Well, as we have highlighted in previous articles, if we use our understanding of how the biggest institutions handle their orders, we can find levels of supply and demand for entries into a trend. It would be obvious to assume that the largest banks would be attempting to sell and buy as much as they can at the highest and lowest prices possible, right? In reality though, they are unlikely to get all of their orders filled due to the sheer volume they are willing to buy and sell. This in turn creates the imbalances we look for which create the supply and demand zones where we teach our graduates to buy and sell. So what’s next for them? They would attempt to sell or buy at new levels in reflection of the overall sentiment change in the pair as the trend starts to develop. Take a look below:

Why the trading the trend doesn't always work

Do you notice the downwards trend in AUDUSD and how new levels of supply are forming as the markets drop lower? This is fueled by both the institutions adjusting their prices to sell as the sentiment changes and also the public who are jumping on the move as well. This is where the trend truly is our friend. During these stages of the trend we can just wait for new supply or demand zones to form and take them in the direction of the momentum. But what about the “bend at the end?” After all, nothing lasts forever, right? Look what happens when some big profit taking in the form of demand steps into the market:

How to recognize a trend reversal

See the sharp imbalance which created a new demand level? When prices returned to this area again in late September, we then saw a rally even greater than the first one. Anyone attempting to trade the trend short would have been scratching their head at this point, no doubt confused by the sharp reversal in prices. Look how long the trend had been running until the reversal. We must be cautious when joining any trend if we are joining it late. As soon as we see a change in sentiment like this (new explosive highs in a downtrend) we should start to objectively reassess the situation and ask ourselves if it is still a good idea to join the trend because a change in sentiment may be developing. After all, the longer something runs the more likely it is to come to an end.

Another clue to a change in trend is a range. We can see this now happening on the AUDUSD after said rallies happened:

Using range when trading the trend to recognize a trend reversal

We can see from the chart above a ranging and choppy market has developed, signaling uncertainty in direction as the major market forces makeup their mind what to do next. We could expect equilibrium for a while, until a new trend starts up. In the meantime, we can play the highs and lows or just sit on the sidelines. In closing, I would say that of course it is ok to continue with trend-trading but always be aware that the longer that trend runs, the more likely it is to put in a reversal at some point. Sure, there are ways to spot these bends in the trend but that is a much deeper topic and something for a later date.

Be well and take care,

Sam Evans – sevans@tradingacademy.com

DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.

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