Playing with the trend can be very profitable as long as we will be able to avoid the many pitfalls waiting for unwary traders trying to open positions with – “eyes closed”, blindly. One of the best ways of earning in trends when we find them is opening transactions in correction and awaiting resumption of the trend and new highs (or lows in case of bearish trend)
The plan is good, but what with implementation? “The trend is your friend” – says a popular saying but much less frequently cited as a whole – “The trend is your friend until it runs out.” The lesson of this saying is very distinct – in theory, each peak in an uptrend and each low in the trend could be the last. Do not blindly believe that the trend will continue – one of the lesser-known sayings says that street (small investors) enters into a trend at the its end because small traders are primarily focused on what they see on the history.
When the trend is already well developed and well visible, professional capital usually opened positions. This is obviously not an absolute rule and there are trends lasting several years stimulating growth in the value of assets. If you enter the trend in a misguided way, easily we can fall in a deeper correction. This will require from us to increase the value of Stop Loss, spoil ratio of profit to risk (RR) and hope for a much longer movement that our trade can be profitable. While the market loves to test too big stop-losses with such perverse consequence that many traders have the feeling as if the market is specially against them. Meanwhile, professional traders focus just on the entrance at the best price at the place promising imminent end of correction so that the risk is very limited, which gives them a large margin.
Why it is worth to measure corrections?
Trying to get a favourable price entering trend we will measure both impulses and correction. Traders often focus on the impulse, a strong movement on which they could earn, but that is correction which provides us with valuable information about the strength of the trend and the resistance on the opposite side. If a bullish trend reaches resistance and forms a bullish triangle, we can say that bullish side is strong. If price on the resistance creates a large consolidation resulting in two or three distinct rebounds then we can say that resistance is strong and can trigger a correction. In case of a lower high in an uptrend and higher low in a downward trend the matter is even simple, since we can clearly see that there is an increase in strength of contrary market due to increased profit taking. It is the shape of correction in the first phase that is the best signal about possible further progress and its overall shape will witness the trend as our behaviour in difficult situations when under pressure from under the cloak of self-control brings out our true behaviour.
Here are two examples of corrections – which trend predicts better continuation?
Impulses and corrections
Basically, the trend can be divided into small and large – a trend appropriate for the time horizon in which we make transactions and the parent trend (longer term) – one level higher. The synergy of these two trends is full of very strong movements allowing a good profit but it is worth remembering that a large correction of main trend is simply a new lower trend. While trading we should always have a good picture of how the long term trend looks like,and how the current trend is placed from our time horizon. The most desirable situation is when both have the same direction the trend of higher and lower order.
Three waves of correction
Basically in trend we expect three waves correction. Many traders fall into a trap trying to buy the first move against the impulse (a) forgetting that probably awaits us even deeper move (c). Here traders often loose on Stop Loss.
Demand and supply
Description of the situation on the chart in terms of demand and supply and determining the technical levels of support/resistance will certainly help to move around the chart and will highlight the areas where price action may give interesting signals to us, especially if they cover with our projections.
Many traders initially limit measuring only to abolition of impulse trying to determine the possible location where will corrections end. Measurement for this purpose alone the impulse is insufficient and exposes us to a strong lack of information, which is key for trader in decision-making.
This tool is used not only to design range of next impulse in the trend. It may well indicate the potential range of the next impulse in correction. The expansion is not a tool for future predicting but only a clue what and where we can expect. If we measure the potential range of the next impulse, it will simultaneously provide us information about correction at its end.
On the other hand, knowing a close approximation of the first two waves of adjustments (a + b) we can use expansion to find possible destination for wave c.
High and Low
Also, the trend lines can be useful in measuring the adjustments and not only those plotted over the lows or highs. The previous impulse high + first low of correction in an uptrend, and the previous low and the first high of the correction in a downward trend, also provide interesting clues.
The principle of changing polarity
It is a rule that says that as general (with some exceptions) resistance overcome by upward trend becomes a support level, and vice versa, support levels overcome by downward trend then become resistance levels. From these places trend often continues its move after a correction. If, therefore, we see that with some level of price trend had a clear problem, after a breakout, we can expect a follow-up orders at this level. To these exceptions includes, among others, false breakout. Also be careful on this level in case of trend reversal (deep correction higher order) because then this level has strongly limited value.
“Expect the unexpected”
In fact, the ability to predict the behavior of price and have answers for the implementation of the various options gives us an advantage in the market and gives us flexibility that complement our technic. Expansions, abolitions, levels, signals – allow us, traders, build variants of the behavior of prices and estimate the probability of their occurrence. That is the art of speculation. The point is not to know what will happen next, what will the price do – because nobody in the world knows, unless you are Mario Draghi or Janet Yellen. The idea is to prepare for the occurrence of specific price behaviors and use it for profit or to avoid failure and excessive losses.
Trading trend and trying to anticipate possible moves is always worth to take into account not only the characteristics relating to the impulse, but also signs of impending correction and its course respect topped by the correction trending movement. Taking into account the different characteristics of these two phenomena gives a far more complete picture than a simple, uncritical basing on the trite and often mistakenly designated formations double high / low, head and shoulders, etc. This set of examples do not exhaust the entire issue, because for description of impulse and correction, you can use a variety of tools, which is a whole bunch available on different platforms.You should always remember the fractal nature of the market – small trends build larger trends – as well as application of various confirmations and assessing the whole picture, not just a partial one. With such a comprehensive approach and a certain amount of experience, our trading will gain in quality.