Trend Structure & Trend Trading Introduction
In order to understand trend trading, let’s take a deeper looking into how trends are formed, unfold and end! The presence of a trending market signifies an imbalance of buying and selling pressure that drives price change. However, price change due to that imbalance will find an equilibrium at a new price level.
So, it is fairly important to know what patterns supports a trend continuations (an imbalance buying/selling pressure) and patterns that indicates trend may come to an end. It is the essence of trend trading.
Don’t Fight Forces, Use Them – R. Buckminster Fuller
What is Impulse and Momentum?
Before that, let’s quickly cover the basic structure of a trend. As you may have read it on my introduction article, Types of Trading Pattern & Market Structure, trend consist of impulse, retracement and impulse move.
The first leg AB, is often known as momentum move or an impulse move. For example in an uptrend, it is a sharp advance of price driven by buying pressure. On a downtrend, it’s driven buy selling pressure instead.
It is usually very obvious in an impulse move due to the huge price movement with sharp movement towards one direction. You probably don’t need an indicator to tell you that it is an impulse or momentum move as well since it is a very sharp movement.
Impulse and momentum candles drives trends and may represent a beginning of a continued price direction. As long as the next few candlestick, also known ‘trend legs’ are consistent with the momentum move, chances are good.
But what we DON’T WANT to see after a huge impulse move is a Sharp Countertrend Movement on one of the pullback. This completely breaks the established trend pattern. It is no point trying to trade an uptrend/downtrend after an event like this happened. It’s safer to assume that the trend is broken until next impulse movement!
By now you probably can tell what’s the basic plan in following a trend. We either buy on pullbacks on an uptrend, or sell on a pullback on a downtrend following their respective impulse movement.
Sounds simple right? There is a complication that most technical analysis favored traders may miss all the time..
Let’s take the below chart as an example. It is showing a classic example of climax in a trend of Silver futures. The worst scenario a trader is to read this trend as an extreme strength to follow. A naive trader that is caught in BUYING the last candle following this ‘extreme strength’ is exposed to a massive sell-off.
What follows that is the preceding buying pressure disappears, pattern change as well as huge momentum is developed in the opposite direction. Hence, traders will go on a selling pressure streak that adds onto the fire.
The movement is also referred to as Parabolic Movement or a blow-off. Typically the range of bars in blow off are much larger than the previous bar while the trend steepens! Usually larger volume spike near the extreme of a climax move like four for five time the average volume. This applies to both uptrend and downtrend climaxes.
Hence to summarize what climaxes are, they can be characterized as:
- It usually comes after two or more trend legs in the same direction
- Accelerates in the direction of previous trend. The trend line is steeper and indicates that the trend moves much faster than before. (Parabolic Movement)
- It usually comes at significant new high or low in the time frame considered. Very rare to see this movement in a middle of a range.
- It is confirmed by a sharp counter trend movement. Else it just means that the trend may be very strong that continues.
- It’s significant meaning varies for different time frame. Small exhaustion in lower time frame into previous support/resistance are common. Which may not define important structural points for market on higher time frames.
In a normal (non-climatic or non-parabolic) impulse move, market will usually go into a pullback also known as retracement. It is a counter trend movement against the trend and usually leads to another trend leg towards the original direction.
Some may refer pullbacks as consolidations, where market pauses and consolidate energy of the previous trend leg. It may be tough to define entry and risk points in this pattern. However it is worth to overcome this challenge because statistically speaking, this pattern tends to favor trend continuation.
Characteristics of a pullback can give you insights to the buying or selling pressure of a trend move. For instant, if buyers are aggressively buying, the price will not retrace much. Instead they will buy aggressively at higher price. Hence producing shorter pullbacks compare to complacent buyers situation.
If buyers are unsure, most will demand lower prices as protection and will not be willing to bid the market aggressively. So we should see deeper pullback perhaps with more complex structure.
Since it is common pattern within trend trading, traders tend to make profits in trends that extent for several legs. Pullbacks in trends also tend to alternative between simple and complex pullbacks. (Alternation between these two pullbacks is a useful rule from Elliot Wave Theory, One of a trend trading concept)
It’s very unusual to find a trend that has five large trend legs interrupted by four simple pullbacks. But instead, it is more common to find five trend legs interrupted by 2 simple pullbacks and 2 complex pullbacks.
The importance lies in understanding the pattern since traders basic plan is to enter a trade at pullbacks and exiting if the pullbacks continues to move against the trend direction.
Often complex pullbacks will stop these traders out of their position as the pullbacks makes a new counter trend extreme on the second leg. So it is important to take into account of complex pullbacks in trend trading as well.
Three Pushes Pattern
One of it is the Three Pushes that seems to be a three drives to a new high or low after an extended trend. These pushes are usually symmetrical in time that seems to be spaced evenly on the chart.
It could look as if the third push breaks a trend line drawn across the pushes one and two, which also looks like a short term climax on a lower time frame.
These three pushes in this pattern are usually spaced more closely than most of the other highs in the trend. This shows that the pace of the activity has accelerated (volume may not necessarily increase).
Just to be sure, it is not necessarily Three pushes too. However, when this pattern occurs, it should draw attention towards a trend termination pattern. It is not a strong indication for a counter trend movement, but it should warn you to reduce your exposure in the current trend movement.
Or at least do not increase your risk on the next pullback because it has a higher probability of failure in this pattern.
Stay Tuned! We’ll be covering an In Depth Description on Pullbacks Very Soon! SUBSCRIBE to BO Sentinel to receive latest newsletters!
Good luck & Trade Safe! 😀