*Reviewing a trend based short trade on the Dow Jones Industrial Average and talking about price trends*
Welcome back to the blog! In this blog post I am going to be talking to you about the topic of price trends, why I use them and how I use them in my technical analysis. I will show you a recent intraday I entered this week and discuss the technical analysis surrounding the trade and why trend analysis played a big part in it. Towards the end of the blog I will show you the main methods I use when identifying trends within the markets with examples you can take and use for reference in the future.
I often get asked why I predominantly focus on technical analysis over fundamental analysis or quant trading. The main answer is that I am better at technical analysis because it is what I know and it is what I understand and have practiced for a long time. I am not yet skilled enough for high level quantitative analysis and although I have a strong understanding of macroeconomics and financial market fundamentals, I always refer back to technical analysis when entering, managing and exiting trade positions.
A wise man once said “Fundamental analysis tells you what to buy and why. Technical analysis tells you when and where to buy it.”
This is one of my favourite quotes and it shows you how both forms of analysis have their own benefits and ideally should be combined when developing a complete trading strategy. However, in my opinion, when it comes down to it only technical analysis gives you the actual point at which you enter a trade position.
Dow Jones Index – short trade.
This trade was perfect example of how only technical analysis can provide a great trade set up that goes alongside the market fundamentals of the week. This short trade had a large number of confluences supporting my bearish bias and giving me the confidence to enter a short trade position on Tuesday.
Firstly, the previous bullish trend had been reversed prior to this trade entry. The bullish trendline had been broken with strong momentum and the EMA alignment had become bearish with the 50EMA now residing below the 200EMA. Price was also now trading below the 50EMA. Price was also making lower highs and lower lows on this timeframe.
The wave count of this trend is shown on the image above. I will explain this in more detail later on in this blog. I will also talk to you about multiple other methods of identifying trends, most of which I used to analysis and enter this short trade.
Monday was a public holiday (Labor Day) in the U.S so the Dow Jones Index was not available to trade at the point of time in the first image. However, on Tuesday morning price was still in my desired short trade entry zone and setting up for a very good entry.
I entered a short position after the rejection of the 0.786 fibonacci retracement level and a large bearish candle closure below the 50EMA. Using this along with the technical analysis previously explained, I was confident that the next move in price would be downwards. I had a conservative stop loss of 200 points which left it way above the previous wick rejection candle highs and an initial target profit set at $27,400 which was 900 points lower than my trade entry.
You can see that prior to this week, US stock indices had lost a lot of ground and sold off with strong momentum after the hype surrounding the major technology stocks finally started to disappear. It is no secret that stock index prices, especially in the U.S, have been solely supported by a few key stocks which were mainly tech companies.
Explain, duration expected to be longer although momentum was much stronger leading in to the previous waves. Therefore moment
As you can see, price continued to sell off with some strong momentum after I entered the trade. There was almost zero drawdown which is actually a good benefit of trading on the back of momentum candles because you tend to get in to trade positions with the move and avoid potential market chop. This trade went to my target profit zone a lot quicker than I expected as price dropped over 800 points in 6 hours!
Having looked back at the trade and reviewed it for my journaling, I can see that this speed of selling was very likely. The previous week finished very bearish with the Dow Jones seeing a drop of over 1200 points in a similar timeframe. I closed the short trade less than 48 hours after entry on the close of a big wick rejection of my final target profit level at around $27,400.
I posted this trade set up on my TradingView profile so you can track the progress of this trade live on a candlestick by candlestick basis by clicking on the link below.
I have spoken about this before in many blog posts but it is never a bad thing to repeat. I use 4 main tools when looking for the prevailing trends on a specific asset or security I am wanting to trade. These are listed below.
- EMA alignment.
- The swing high and swing lows of price action.
- Wave counts.
The alignment of moving averages or exponential moving averages (EMA’s) in this case, can be used to indicate the prevailing trend of a financial instrument. The idea is that you use a smaller period EMA (50) and a larger period EMA (200) and depending on whether the smaller period is above or below the larger period EMA, this dictates the trend.
- 50 EMA above the 200 EMA = Bullish
- 50 EMA below the 200 EMA = Bearish
The two chart examples below show both scenarios.
I also like to use the relationship between the 50 EMA and the actual market price to assist with trading trends. You will notice on a lot of my previous trade examples I have the 50 period EMA showing and use it as a dynamic support/resistance for price depending on the direction. If price has broken down through the 50EMA and then pullback to retest it, I will use the 50EMA as an extra confluence when entering a short trade. The opposite can be said for a long trade.
- Price is trading above the 50 EMA = Bullish
- Price is trading below the 50 EMA = Bearish
The chart below shows the EURUSD currency pair on the 1 hour timeframe. As you can see in this scenario, the 50EMA provided excellent support for price as it continued on its bullish trend and buying the bounces would have proved very profitable.
A big limitation of using EMA’s in technical analysis is that they do not work well in choppy or consolidating markets. This blog post is all about trend trading and identifying trends. If you were to use these techniques in other types of markets structure then you might struggle to find good and successful trade entries.
One of the simplest methods of determining a trend that you can trade is by looking for the swing high and swing low points being made and take note of them. This is another part of technical analysis that I often use in blog posts and if you are regular reader fo my blog you will be used to seeing HL, HH, LL, LH on my charts.
If price is making higher highs and higher lows then the trend is moving upwards over a period of time and should be considered bullish. Therefore it is prudent to be looking to buy the dips and enter long trades on the next higher lows to be trading with the trend.
Alternatively, if price is making lower highs and lower lows then the trend is moving upwards over a period of time and should be considered bearish. Therefore it is prudent to be looking to sell on any rallies in price and enter short trades on the next lower highs to be trading with the trend.
The table below outlines the different swing highs and swing low points and what they mean. Please be aware of when there is potential indecision and see how I bias higher lows for bullish trends and lower highs for bearish trends.
|Higher Highs||Lower Highs||Flat Highs|
|Higher Lows||BULLISH||CHOPPY (SQUEEZING)||BULLISH|
|Lower Lows||CHOPPY (EXPANDING)||BEARISH||CHOPPY (EXPANDING)|
|Flat Lows||CHOPPY (EXPANDING)||BEARISH||PRICE CHANNEL (REFER TO |
IMPORTANT! This blog post specifically relates to identifying and trading trending markets, not range bound markets or indecisive markets. However you can use EMA’s and swing high/swing low price analysis to determine when to trade but more importantly, when NOT to trade.
If you see the 50EMA and 200EMA crossing over each other multiple times and price breaking above and below the 50EMA on multiple occasions then that means there is not a strong prevailing trend. If you are struggling to identify whether price is making higher highs/lows or lower highs/lows then the market structure is likely choppy or consolidating and a trend trading strategy will not be effective on that timeframe.
Trendlines are one of the most common “tools” in retail level technical analysis. They are easy to draw, highly flexible and adaptable to many strategies. I use trendlines in my technical analysis as an extra confluence when looking for higher lows or lower highs and price reversal points in trends. There are multiple ways of drawing trendlines using candlestick high prices, candlestick close prices, line charts and there is no right or wrong way.
An example of a bullish and bearish trendline can be seen below.
Using trendlines for identifying price bounces is pretty self explanatory but one major error I see many new traders make is treating them too “perfectly”. Much like price support and resistance, trendlines should be treated as zones and not a single pip value line. Aggressive traders looking to flip accounts and make huge leveraged gains will look to trade exactly at the trendline and leave themselves open to price spikes and intraday volatility.
Don’t be greedy, keep things conservative and play the long game.
My final method of analysing trends in the market is wave counts. This follows on from identifying the swing high and swing low points of price in order to determine the trend and then analysing how established the trend is. As trends continue, they can lose or gain momentum and this is why I prefer to trade with the trend instead of against it because it is very hard to predict the new higher high points of a bullish trend instead of buying the new higher lows.
There is a way of analysing how likely a trend is to continue in its current direction and that is to wave count using the Elliot wave theory.
The basic idea behind this theory is that for the majority of the time, trends move in waves of 5 and 3. The main trend will tend to have 5 clear waves consisting of 3 legs in the intended direction and 2 counter trend waves. The counter trends will likely consist of smaller waves of a similar pattern.
I won’t go in to huge detail on the technicals of the Elliot Wave Theory because it is not mine and I did not invent it and it has been covered by many other financial education sites. However, I will tell you how I use it.
If I am trading a bullish trend that has made 5 clear waves in a way that is similar to the first part of the image shown above then I will be looking to hang back on entering any more positions for the time being. This is because the probability of the trend making further bullish waves is decreasing as time goes on. In my opinion, the best entry point on a trend is at the end of wave 4 before the 5th and “final” wave continues. This is because the trend is established, there should be no more counter trends and you will also likely have a trendline drawn for extra confluence and a previous price support/resistance zone from the last higher low or lower high depending on the trend direction.
This is why higher timeframe analysis is also very important and it is a subject I constantly talk about when teaching people to trade. Trading trends in to higher timeframe price reversal zones or not paying attention to the larger price waves of the market will also start to lead you in to unsuccessful trades.
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DISCLAIMER: None of the information posted on this site is to be considered investment/financial advice. Trading is high risk and you should only trade with money you can afford to lose.