Trading against, without a trend, or just trading poor quality trends is one of the most common reasons for trading losses.
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Quality or tight trends have a higher degree of predictability than poor quality or choppy trends. The certainty of a trend lies in a controlled arrangement of candlesticks with controlled pullbacks that reverse at supply or demand.
Poor quality or choppy trends have a much lower level of predictability. The uncertainty of a trend can be seen easily through an uncontrolled arrangement of candlesticks and uncontrolled pullbacks into supply or demand.
Changes in trend quality are a warning sign that no trader should ever ignore. Any time the quality of a trend starts to change it can be viewed as an opportunity to take profitable action. This profitable action can be anything from moving your stop loss orders closer to the market to lock in profits to capitalizing on early trend changes.
A change in the angle of ascent/descent or correction is often another warning sign that the market may change direction. When markets have a normal 45-degree angle of ascent/descent and then the angle becomes very steep this often ends that trend and there may be a trading opportunity. This kind of parabolic move often results in very sharp corrections due to increased volatility. Greed or fear has become extreme.
Tradersneed to be able to define the differences in tight or choppy trends so that they can develop the discipline to trade only the best quality trends that have a higher level of predictability.
Tight Trends
Tight trends will have the majority of opening prices in the area of the prior candlesticks closing prices creating a smooth transition from one candlestick to the next. The candlesticks will move in the same direction as the ones that preceded them and will have few tails. This pattern of opens and closes produces few gaps, tails, engulfing bars, and piercing or outside bars in a tight trend.
Very tight trends can have large moves without experiencing any form of pullback. A reversal after a pullback has high odds of trend continuation.
In tight uptrends, bearish candles will have little effect and pullbacks should stop at the nearest support point (demand). As the certainty of traders increases, demand points will rise with the trend and pullbacks will generally be shallow.
In tight downtrends, bullish candles will have little effect and rallies should stop at prior resistance (supply). As the certainty of traders increases, supply points will drop and rallies will be shallow and short-lived.
Figure 11.1 shows a picture of a quality tight trend. Traders are certain and the majority are in agreement. Pullbacks against this uptrend have little effect and reverse at demand ( support) areas. This is the type of trend that traders should be focusing their trading on. If you can’t define a quality trend on the market you are watching then move on to another product to trade, there are thousands to choose from all over the world. Many brokers offer 24-hour trading on many different global markets all from one account.
Figure 11.1 – Tight Quality Trend.
Choppy Trends
Choppy trends will not have many opening prices in the area of the prior candlestick's closing price. The opens and closes will tend to be all over the place. Each new candlestick may or may not move in the direction of the prior candlestick. This pattern of all over the place opens and closes creates many tails of various lengths, engulfing bars, outside bars and gaps creating a low odds trade scenario with very little predictability.
Pullbacks against the trend will often break through minor areas of demand ( support) or supply ( resistance). Traders are not in agreement and this creates an internal struggle between the bulls and the bears over the direction. A choppy trend is not a picture of quality or certainty and creates a very difficult environment to trade in. Traders would be better off sticking to quality tight trends. If you can’t find anything good on the chart move on to something that has better trending characteristics.
Figure 11.2 shows a picture of uncertainty, traders are not in agreement. Tails are very long, there are engulfing bars all over the place and no progress has been made in one direction or the other. This is a very choppy trend that would be extremely difficult to trade and would likely result in trading losses. If you can’t define a nice tight trend then move on to something else that has a higher level of predictability.
Figure 11.2: Choppy Trend with Low Predictability