Tuesday, October 15, 2013

A lesson in trend change


Click on chart to enlarge. 

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Trends go up and trends go down. Sometimes they go nowhere, which is to say that the price becomes  range-bound. The techniques for trading ranges are fundamentally different from those for trading trends, but it is trends we are concerned with here.

While price may go from a low level to a high one, or vice versa, it will not do this in a straight line. For various reasons there are always retraces, which in turn gives rise to the idea that a rising trend is characterised by higher highs and higher lows, while for a falling trend the situation is exactly reversed.

In the chart above we are looking at the daily record of the price of gold. At the left hand side, the trend is up. Each time the price falls it turns around and resumes its upward tendency before it can have an opportunity to fall below the previous low. This situation exists up until the point marked “1”. A long trade would then have been stopped out at or near this point.

Trend changes at “2” and “3” are also marked. Going short at “1” would have been justified, even thought that particular trend did not last long and such a trade might even have resulted in a small loss. This is the cost of doing business in trading and it is for this reason that money management techniques have been developed and must be used.

An experienced trader would be aware that the 200 day Simple Moving Average (SMA) is falling (Blue line) and that the price is below it. This means that the dominant trend is down. More conservative traders will only place trades in the direction of the dominant trend, while aggressive traders will follow each trend direction as it arises.

Trading styles differ, but for all traders careful attention to each of the above principles will repay dividends. It is not too much to say that such awareness will represent the difference between a profitable account and an unprofitable one.

The following chart shows the dominant trend more clearly:

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