by Rick Ratchford
At first glance, a price chart can look like chaotic. To the dismay of traders the world over, sometimes it just looks hopeless to determine which way the market is going to go in order to trade and profit. Naturally if it were simple to just look and know instantly what to do, then there would likely be no market at all. Who would take the opposite of your trade? Even the hedgers would change their way of trading and go for the easy bucks rather than just locking in their pay for the year. Who wouldn't if it was clear as day which way it is to profit?
The bottom line is that to a large degree it is quite simple. But as with anything else, it is in the eyes of the beholder. A 'trained-eye' can work wonders. Such an 'eye' helps a painter produce masterpieces that others can only admire. Such an 'eye' helps the basketball player find the lane, thread the needle and hit the basket better. It helps the football player find the gaps in the defense. A 'trained-eye' is the difference between quality furniture and future firewood.
As with all the above listed endeavors, it takes time to develop such an eye. Often as with anything, many stop way short of reaching journeyman status in many fields. Same goes for market analysis and trading. It isn't just a way to make an incredible amount of money, it's a craft that requires respect and a great deal of desire. This is what separates the believer/achiever from the griever.
There are some very simple and basic rules about market patterns that must be understood completely. The market at any given time is going to trend up or trend down on any given time frame. You may be wondering why I did not also say 'sideways'. In actuality, the market NEVER moves sideways. To prove this, look through all your price charts and find any market that trades at the same price, day in and day out. Price always moves up or down or it isn't being traded. What appears as sideways on one time frame is a market that is actually trending on a lower time frame.
What do you see when a market trends up? You see price bars making higher highs and higher lows. When you lower the time frame being viewed, you'll see that this is actually a pattern of higher swing bottoms and tops. Swings, or also called pivots, are the extreme price points on the price chart. For example, a swing top is when price stops making higher high and instead makes a lower low. Price thus 'swings down' to that lower low. Or when price is making lower lows and then stops to make a higher high instead. The point it stopped making a lower low is considered a swing bottom. Fans of W. D. Gann well know that you can add rules to such swings, such as requiring two or three higher highs before a 'swing' can actually form. Whatever the rule applied, the result is the same. Bull trends tend to form higher swing bottoms and tops and bear trends happen to form lower swing tops and bottoms.
Therefore, trend identification is achieved by looking for those swings at different time frames to determine which why the market is likely to move. Fans of Elliot Wave know that trends tend to move in 'waves'. The trend is considered to be made up of usually 5 waves, 2 of them a trend correction. Of course there are exceptions and Elliot sure had his. One is that wave 5 can extend. But the point is that these waves are actually 'swings' that can be identified. Are they swinging higher or lower? You then have your direction.
The old saying that the "Trend is your Friend" is true. You make money when you are trading in the direction the market is actually moving. Of course, as stated earlier, the trend all depends on the time frame you are looking at. So from a macro view, you would be trading with the trend no matter which side of the market you entered from, short or long. It really depends on the time frame you are basing your trade on, intraday (minute, hourly) or higher.
The shorter the time frame the quicker the moves and the smaller the risk exposure, although you can trade at too small a time frame (like a one-minute chart or tick chart) and find the execution speed of your platform isn't fast enough to deal with it. Such is best for the floor scalpers. The larger the time frame and you can find yourself having to put on trades requiring a large stop-loss.
If you follow the swings, no matter the time frame, you can identify the trend. When you identify the trend, then you can trade them by entering at the end of their corrective waves for maximum profit potential and minimized risk exposure (once the end of the corrective wave has been identified/confirmed) or at the breakout of the prior impulse wave extreme (bull trends end each impulse wave with a swing top and end each corrective wave with a swing bottom. The reverse is true for bear trends.).
So learn to identify the swings in order to help determine the trend. Then make the trend your friend by taking advantage of what you know about it, that which has been described in this article. All that will be left is to learn how to time the end of those impulse or corrective waves, in other words, to find those swings that make up the trend. Once you learn this, you will then have a 'trained-eye' and the price chart will no longer appear as chaotic as it originally did.