Is the Trend Really Your Friend?
10/24/2012 6:00 am EST
One of the first things a newbie trader learns is that the trend is your friend. CMT Marc Principato of SMB University qualifies that common adage.
We’ve heard it a billion times: The most effective way to trade the forex market is to trade with the trend. Like 80 years ago some fast talking high pants guy probably at the New York Stock Exchange said, “The trend is your friend, see?” So now what do we do? Find a chart that looks bullish and press the buy button.
What Mr. Fast Talking High Pants never mentioned is which degree of trend is your friend. You see, market structure is fractal in nature and this means you can have smaller price trends within larger price trends. The confusion sets in when the smaller trends are moving counter to the larger trends.
For example, if you pull up a 5-minute chart, you may see what appears to be a bearish trend. Meanwhile at the same moment, if you pull up a 30-minute chart in the same instrument, you will see an apparent bullish trend. The 5-minute price action appears as a small blip within this larger price structure. So the question is: Which trend is your friend?
Enter multiple time frame analysis. This is the study of relating the smaller time frames to the price action of the bigger picture. From the perspective of a short-term trader, by extracting relevant information from larger time frames such as 4-hour, 1-hour, and 30-minute, you can gain perspective on two important factors that go into your decision making process: trend and levels. Since the larger time periods account for larger amounts of volume, it is reasonable to expect higher volatility, which is accompanied by higher risk.
Here is one way to put such information to use: Let’s say you identify the bigger picture trend as bullish. The market is off its recent peak, though, and has been consolidating on your 30-minute chart. Knowing that the bigger picture is simply consolidating gains can help you prepare for intraday trading opportunities. Here’s how: You have identified a larger time frame support within the consolidation. Your 5-minute chart, which starts out pretty bearish, starts to consolidate and show signs of potential reversal around with larger time frame support. In this context, the logical thing to do here is look for longs, right? In reality, most new traders are too focused on the 5-minute bear trend to be able to recognize price has reached a significant support and is preparing to go higher. So they are usually still looking for shorts.
So the next time you read “the trend is your friend” remember it really all depends. The question you have to ask is: “Where am I in the bigger picture and how is my smaller picture unfolding at significant levels? Am I buying a larger time frame support? Or selling into a low of a larger bullish trend that the entire world is waiting to pile into long?
Once you gain a strong understanding of how to relate the different degrees of trend, you will be much better prepared to think ahead of the price action and measure risk in a more effective way.
By Marc Principato, CMT, Director, SMB University Forex Training Program