Understanding the Market with a Pattern of Trends- Identity Repetition and Trend Recognition

Trend Trading Strategies

technical analysis trend recognition

Most markets and sectors, which make up the economy, are influenced by heavy trends. For example, in the luxury goods market, consumers are interested to buy quality goods such as Louis Vuitton or Mont Blanc which is developed as their preferences build up to buy quality and luxury goods. As many individuals buy any kind of goods they attract an increased number of consumers to form a ‘crowd’ and tend to buy more of similar products. Similarly, when financial markets start to develop a trend, more and more number of traders, speculators, fund managers and financial institutions form a ‘crowd’ and continue to follow the trend. The higher number of traders following the trend causes it to grow in stature and demand. It is just like leaping onto a train to reach a particular destination and this is how a trend develops and continues in one direction.

There are many ways to analyze and predict the market such as technical analysis as the decisions investors make would be based on the charts where it tells you when to buy or sell. One of the ways to use technical analysis is to identify recognition patterns (indications) in the market which can turn out to be attractive and at the same time profitable. Trend following is an investment strategy that helps in taking the benefit of the long term moves which are very common in the financial markets. There can be two ways in which a trader benefits from a financial instrument, a currency pair for an example, i.e. either through buying or selling. If the relative strength of those who are buying a particular currency pair is greater than those who are selling the same currency pair from the market or vice versa, certain trend formations and patterns can be formed which market participants will try to observe in an attempt to predict specific prices. Once these specific prices have been observed in the market, then other traders would also jump on the trend and ride it which in this case is buying more of the currency pair. Generally, these types of trends which are happening in the market are similar to tides and waves. 

A particular trend can not only tell you when the market is continuing in a particular direction but it also might give you indication for reversals and breakouts. Any trend can be identified by looking into at least more than two high or low prices in the same direction which can be connected and formed as a ‘market moving in a channel’.

Traders commonly use this phrase for describing the market: ‘Trends are your best friends’. But the main guideline or concern for traders in a Trend following strategy is to know at what price to enter the trade to benefit from the trend. Traders who might use such kind of strategies might enter in a trade using trend following strategies but might be possible that the trend would already been finished. So it is very important to also know at what price to enter and is likely to continue for a reasonable amount of pips.

For starters, I have attached a chart clearly showing the bearish trend and flowing in a downward channel. There are ways in understanding the behaviour of the market movements, arising to a downtrend market such as above through technical analysis:

• When the market has created ‘lower lows’ and ‘lower highs’ it shows a downtrend bearish movement as showed on chart. On the other hand, when the market has developed ‘higher highs’ and ‘higher lows’ it shows an uptrend bullish movement.       

• To use this type of trend trading strategies, the market should create higher highs and higher lows at least 2 or more than 2 times for recognizing an uptrend pattern and vice versa for a downtrend pattern.

Before getting on to know how to trade in such price momentum patterns, it is very important to get aware of the basic technical terms. Support and resistance concepts are very common technical terms used by fund managers, financial institutions and most of the traders which gives an indication for further price movements. In the financial markets, prices are driven by supply and demand of the particular financial instrument.

A Support is a price level below the current price at which demand is thought to be strong enough which prevents the price from falling further. At the support level price, it gives an indication that the particular currency pair has exceeded its supply and price might rise from this ‘floor level’.

Resistance levels are the opposite of the support level where the price level is above the current price at which supply is sought to be strong enough which prevents the price from rising from this ceiling level. Both support and resistance levels are developed when a particular currency pair price is repeated at a particular price level. 

technical analysis trend recognition Resistance levels

The greater number of times the support level is holding or preventing it to fall from a certain price, the stronger it becomes. Similarly, when the price of a currency pair is unable to break the upper level the resistance level becomes firm. So when price reaches such levels it becomes identified by major market players so they can take advantage of this price.

When demand for a particular currency pair increases (say due to some positive fundamental data), the price of the particular currency pair becomes highly attractive as traders and investors would buy more and get the benefit of the rise in price and this would enable the market participants to sell at a higher price at some future date. At some point in time this will lead to excessive demand. This excessive demand price could act as a resistance level which would help to prevent the particular currency pair from further increase. Another scenario to look at this is when the support and resistance level can be broken which is called the ‘breakout’ phase.

technical analysis trend recognition breakout

Trends are built on market momentum with more and more traders preferring to have a same position whether ‘buy’ or ‘sell’ in a same direction. The momentum often heats up when there are traders who think either the particular position has been oversold/ overbought or should sell/buy more of a particular currency pair. Once the trend has been confirmed then it is much easier to predict the future movement flowing in a channel unless and until the trend has been disturbed or interrupted. There can be three different ways in which a trader is comfortable to trade using the trend patterns - going along with the trend especially if you have understood the trend, using specific trend reversals which can be used when rebounding from either the support or resistance level of the trend or waiting for a breakout from the channel. Breakout from the channel can mean either the market bursting/breaking the resistance or support levels which is represented by the blue arrow on the chart above.

It is much easier to trade on a particular currency pair if you know how it usually performs. A trend on a particular financial instrument can become strong when you see more number of times it has rebounded from the dips or hikes and still stays within the channel range.

technical analysis trend recognition uptrend

technical analysis trend recognition downtrend

Trading by following trend patterns can occur in 2 forms:

Trading within the channel trend

• Trading in the same direction of the trend: Selling from the downtrend channel resistance/Buying from the uptrend channel support.

• Reversal Trading against the direction of the trend: Buying from the downtrend channel support/Selling from the uptrend channel resistance.

Waiting for a breakout to happen

• Continuation Breakout: ‘Breakout’ as explained earlier is when it is already exploded from a given trend. Continuation breakout is an extensive move in one direction where breaking of the trend will still follow in the same direction but deeper. Example: If the channel continues on an uptrend waiting for it to break the channel uptrend and it breaks the higher level of uptrend and the market still moves higher.

• Reversal Breakout: Reversal breakout is a type of breakout which is breaking from a particular trend which indicates a reversal. Suppose a particular currency pair is rising in a pattern and uptrend is formed, after a while when this uptrend has created a breakout then this pattern shifts from uptrend to downward pressure and gives an indication for selling the currency pair as the price can tumble to lower levels. So selling from a higher level in the anticipation of falling prices can bring you profits when you buy the same currency pair at a lower price to clear your position.

Avinash Bhojwani