How to correctly identify the trend — part II
This article is the second part in a series of
trading lessons by Dave Floyd.
You can read part 1 here.
Dave Floyd is a professional FX and stock trader based in Bend, OR and the
President of Aspen Trading Group. Dave’s approach to FX combines technical
and fundamental analysis that results in trades that fall into the swing
trading time frame of several hours to several days. For a free trial to
Dave Floyd’s Daily Forex Alerts
or call 888.484.8220 ext. 1.
In
last week’s article I discussed the way I determine the trend prior to
entering trades in the FX market. While the article was rudimentary in terms of
its approach, it drove the point home. Naturally, the drawback to that
one-dimensional approach is that it only dealt with determining the trend on one
time frame. While this style/approach may suit some traders, I find it more
efficient to look at multiple time frames as a way to potentially increase the
odds of success on a trade.
This week, I will build upon the concepts from last week and begin to
demonstrate how looking at one or two additional time frames can be a useful
process.
First, let’s review what was discussed last week. What is the trend on the chart
of EUR/USD below?
There are actually two correct answers:
1. Sideways
2. Down
Prices are below a slightly downward sloping
moving average.
This is not a chart that demonstrates an up-trend. However, what is your answer
if at the same time you were looking at the 240-min chart of EUR/USD versus the
60-min chart noted above?
Here, there is only one answer; the trend is ‘Up’.
So, when you combine the analysis of both charts you sort of have a dilemma. If
you are looking to execute the trade off the 60-min chart, it makes it tough to
go short (despite 60-min trend being down) when the next higher time frame is
indicating that you are going against the overall trend. Conversely if you are
looking to execute off the 240-min chart, the 60-min chart is less relevant and
you would look to isolate high probability long entries. Higher time
frames should always take precedent.
This is the part of trading where it can become more ‘art’ than ‘science’ and
hence highlights the serious limitations of a purely mechanical approach. As we
get further into this series of lessons, it will become even clearer how
subjective the distinctions can become.
Let’s look at another example. In this case we are presented with three time
frames for analysis. While the 240-min and daily charts are in a clear
downtrend, the 60-min chart is likely to limit downside moves due to its current
technical condition.
What is the answer then? Wait for more information.
For those that are familiar with my work, you know that I am always of the
mindset that sitting on your hands can be the most effective trade. Is there a
way for a trader to make money on EUR/JPY to the long side? Absolutely, but the
probabilities of this trade playing out are reduced because of the higher time
frames.
While I understand that this week’s lesson may have been a bit confusing and
left you with no clear answers, (it’s OK, it is a tough concept to grasp when
you continue to add new variables) in the lessons that follow, there will be new
studies added that will begin to offer you an ideal and relatively simple way to
identify the trades that have the higher probability of playing out. While trend
identification is key, it is only one piece of the puzzle.
As always, feel free to send me your comments and questions.
Aspen Trading Group