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Friday, November 9, 2007

A Few WORDS ABOUT THE TREND

I think that most of us heard such a saying as “the trend is my friend”. Many of us also had met in Internet and books different opinions as to the sensee of the above saying..

Well, what is the real meaning of it infact?

The real deep meaning and idea of this saying is a simple and clear demand: Always Trade in the direction of the current trend and ignore trading signals directed against the flow of current trend.

Friendly trend will remain friendly generally, while the trader treats him like a friend , not doing any thing against the desire and will of his friend/trend. Do you know friends who would not be disturbed or irritated by your doings against their desire, understanding and will ? Nobody likes such things.

But nevertheless, many of us starting examining charts/tickers etc absolutely forget this simple rule and try to catch the high or low peaks and/or to trade against the trend. This means, that the trader lacks the main thing - discipline. It's very interesting, that the looser, while considering and investigating his own mistakes, often does not see his actual mistake and culprit - trading against the trend.

How can we define the trend ? Very simply - with the help of combination of four Simple Moving Averages (MA). For example, let us take combination of 5/20/40/60 МА.

Usually current trend is defined by looking at Daily chart and this is right. But the traders with small cash amounts may define trend at 4-hour chart and 1-hour chart. As it often happens that in the interests of relatively quick trading the trend may be defined using only 1-hour chart. But we shouldn't forget about the Daily chart, coz if the hourly signal coincides with the daily trend, then there appears a brilliant possibility for a mighty movement along the trend.

But let us return to the above mentioned combination of MAs. So, if МА 40 is above МА60, then the trend is upward and each time when MA5 crosses MA20 upward (that is in compliance with the trend direction), we enter the market. But when MA5 crosses MA20 downward, we use this signal only for closing of previously opened positions.

And vice versa, if МА40 is under МА60, then the trend is downward and now we enter the market only when MA5 crosses MA20 downward, and we use upward crosses of MA5 and MA20 only for closing opened earlier positions. SIMPLE??

Look at the above Chart. The red dots in there at the above chart denote the crosses of MA40 and MA60. Blue and red lines show the places for openeing positions in the trend direction.

I know of traders, who, in the situation alike trying to catch the price peak, opened SELL positions near the blue lines. If the trader opens positions without minimum analysis at least for definition of the current trend, then he would better go to casino and gamble off, where one can always trying to guess right, but never can make a prognosis. There exists an opinion that MAs are lagging behind as an indicator. It’s true, sometimes, but as a trend indicator, they are very good.

Here МА5 - green, МА20 – red. Red dot - place of closing position ( MA5 crosses MA20 downward). Blue dot - place of opening position in the trend direction (MA5 crosses MA20 upwards ).

We have the same at this chart - red dots - places of closing positions, blue dot - place of opening position in the direction of the current trend.

But WHERE should we place a stop-loss ?

If we enter the market just after the cross of M40 and MA60, then the best place for stop would be 2-4 pips beyond the closest peak directed opposite to our market entrance direction. If you agree, of course, with the size of the stop-loss, or if your collateral permits such stop. But if we opened position some time after MA40 and MA60 had been crossed, then the best place would be 2-4 pips beyond MA60, then, a bit worse, but still ok, beyond MA40 and the weakest variant is beyond MA20.

It’s only natural that the combinations of meanings for MAs could be whatever the trader would want , cause nobody can prevent him from performing experiments. Here are some examples of four simple MA combinations : 10/20/60/80 or 8/12/24/48 or you may even use Fibonacci numbers like 8/13/34/55 or 13/21/55/89 etc.

The main idea in the combination of four MA is that the pair with big numbers defines the existence of the current trend and the pair with small numbers permits us to effect relatively quick trades.

Here is one more example of trading with the trend. Upward cross of MA40/60 is designated by two blue dots. Red dots are denoting the places of positions closing after MA5/20 were crossed downward. One blue dot shows the place where the position in the direction of the current trend was opened again after MA5/20 had crossed upwards.

The next chart is the same as above, but along with the aim of comparison it has another combination of four Simple Moving Averages - MA8/13/34/55.

I understand perfectly that all stated above is not a brand new concept or something. But looking at newbies I noted that disregarding the current trend is one of the most often met mistake, which can lead to potential heavy losses. Therefore, the aim of the above material is to remind and emphasise once again about the necessity for checking the trend direction before entering the market.

Good luck!