We’ve probably all heard the expression Let the trend be your friend, and sound advice it is too. Jumping into a stock or future while it’s priced low and riding it up an extended trend is a great way to trade. And if it was that easy, then we’d all be doing trend trading and we would all have bigger bank balances than we do now, right? The problem, as any trader knows, is how to know when a trend is starting, and just as importantly, when the trend is about to end.
Many traders spend an inordinate amount of time trying to come up with fancy ways of signalling trends so that they may find easy, profitable trades. They put together all sorts of fancy combinations of indicators. Exotic moving averages, DMI, CCI, you name it somebody is trying it in the hopes of coming up with the ultimate trend trading system.
Unfortunately, indicators by their nature are generally lagging. They use past prices in their calculations and so are very good at telling you what has already happened. Personally, I find it just as easy to look at the price and say, “Yup, that’s going up, that’s a trend”!
But I digress. In this quest for finding trends to trade directly, traders are ignoring an altogether different aspect of trend trading: the use of trends as trading filters.
A Higher Calling
When we enter a trade, we want as many things going in our favour as possible. We want to be trading on the side of the greatest probability. Finding a trend in a stock or future is one way to find probability. If the price is in an uptrend then the probability is it will continue up or at least go sideways. Newton tells us it will take greater force than is currently exerting itself on the price to make it turn around. But we can use trends in the bigger picture to add to that probability.
How so? There are two simple ways. The first is the use of multiple time frames. It doesn’t matter what instrument you trade, or what timeframe you trade in, looking at a higher time frame can give you a distinct advantage. For example, if you normally trade the ES on a two minute chart, try taking into consideration a fifteen minute chart as well. If that showed a very strong uptrend, ignoring short signals and trading only on the long side would put you on the side of greater probability because you would have the longer term trend on your side. Remember, for the trend to turn will require a greater force to take control of the price. The higher the timeframe of the trend, the greater the force required to change it. If the sixty minute chart also showed an uptrend, you would have even more going for you.
The Wider Market
The other way of using bigger-picture trends as trading filters is to consider those which exist in rest of the market (or even whether a trend exists at all). This is particularly beneficial to stock traders who have various levels of market action to look at; sectors, exchanges, indices and so on. For example, a trader watching GOOG (Google) can look at the tech sector (because Google is a tech company) to find a bigger-picture trend. If the NASDAQ-100 tech index (NDXX) is falling away rapidly, it is likely to drag heaving on Google, and so short trades would be the order of the day, if you’ll excuse the pun. One level up from the NDXX index would be the full NASDAQ 100, then the NASDAQ Composite, and so on.
Futures traders can also use the bigger picture. An ES trader watching the Dow and the NASDAQ will be able to spot strong trends affecting the whole market, as well as divergences between different indices which would suggest that caution was required.
Avoid Isolation
Trends can indeed be your friend, but not just in the isolation of the stock, future, or timescale you are trading. Pay attention to the trend in the bigger picture and you’ll give yourself aN extra edge. Successful trading is about finding edges like this and putting them to use together to give yourself the best possible advantage. There’s nothing complicated here, no secret combination of complex indicators. A few simple edges is enough to tip the balance of probability in your favour. Combine that with solid money management and cast iron discipline and you cannot fail to make money over the long term.