Matthew Kerkhoff, options expert and editor of Dow Theory Letters, continues his 14-part educational...
Know When a Trend Is Not Your Friend
04/04/2011 11:35 am EST
Learn to identify when markets are shifting course in order to make adjustments and stay on the proper side of the dominant trend.
Newer traders are always seeking out the opportunity to buy the absolute low or sell at the absolute high of a move. Seasoned traders know that in order to succeed in trading, you simply need to identify and trade the high-probability/low-risk opportunities and that bottom picking or top picking is a fool's game. To make consistent profits, you need to trade in the direction of the dominant trend and trade the impulsive moves in that trend.
What happens when the trend changes though? Is there a way to recognize the change of trend as it is happening? Many of you are familiar with trend reversal patterns and how to identify and trade them. But what happens when the trend shifts without presenting a visible pattern? Is there a way you can identify when the trend you have been trading needs to be abandoned and a new stance on the market becomes viable?
The answer is yes. You can fall back to the basics of trend definition and parts of a trend to help decide when to change trading direction. This will not allow you to pick the absolute tops or bottoms, but you can see when the markets are shifting so you can trade in the direction of the newest dominant trend.
In an uptrend, you will see higher highs and higher lows. The impulses, of course, would be to the upside. If you happen to have a downward impulse that breaks the low of the preceding bullish impulse, you can no longer be in an uptrend in the time frame you are watching, as a lower low is not part of the uptrend definition.
The same guide can be used to look for the end of a bearish trend you are trading. A downtrend is a series of lower highs and lower lows. The impulses should also be in a downward direction. The sudden appearance of an upward impulse that violates the pervious impulse's high also breaks the downtrend as a higher high cannot be a part of it.
So when trading, let the trend be your friend. And when that friend leaves, it may be time for you to exit the markets and make a new friend.By Brandon Wendell, instructor, Online Trading Academy
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