Trade Evident Trends
If there are various situations that offer trading opportunities, then why do most traders say “the trend is your friend”? When we think about a clear trend, we should think about it in terms of how clear the underlying sentiment is. There is usually a very good reason for one-way flows in any market.
GBPJPY 1H Chart – Pepperstone MT4
If there are one-way flows, then the easiest choice should be to “go with the flow”. Think continuation, rather than reversal. Instead of watching a market rise and asking yourself where it will stop, ask yourself “where is a good place to join the flow?”
Especially in the currency market, where it's more difficult to assess the actual fundamental flavour at any given time, confusion leads to more powerful price-led trends, creating a larger degree of overshoot. Some say that currency trends are vicious; they’re fickle and come out of nowhere. The matter of fact is that if there is a trend, we want to join it and not fight it.
Spot consolidations
Prices hardly ever continue straight in one direction for extended periods of time. There are usually corrections, pullbacks and fake-outs, which make trend following a little more difficult than simply entering at will in any given trend. We can say that the market needs to digest the move it just made. It needs to consolidate the gains (or losses) before moving further. One of the main qualities a trend trader must have is to be able to recognize when a trend is pausing and when it is resuming (if it ever resumes). Let's cover a few consolidation-contraction patterns:
The symmetrical ascending triangle: lower high, higher low. Expect a break higher. Invert for descending triangle.
Right Ascending Triangle: a double top with a higher low. Invert for descending triangle.
Here is a real life example on USDJPY:
And sometimes you need to drill down to a lower timeframe to catch the entry before momentum kicks price too far away:
Rally-Base-Rally: after an impulsive move, price consolidates. Expect a break higher. Invert for the Drop-Base-Drop. Here’s a real life example:
And now let's cover an expansion pattern: the broadening formation.
Clear megaphone formation on GBPUSD Daily Chart
Also called the “megaphone” pattern: when you see higher highs AND lower (or equal) lows,, cease and desist until you get a read on the new direction. It's a volatility expansion but the market has no real direction yet. Stay away, don’t trade it, and wait until a clear trending structure forms.
GBPUSD 4H chart – Pepperstone MT4
From the initial broadening formation, the market then prints 2 consecutive “inside” weeks, with price chopping around in the megaphone formation. Essentially, volatility is contracting and price is getting ready for a break on either side. That’s when we start paying attention to structure again.
GBPUSD 4H chart – Following price, we violated the potential downwards move, initiated a transition (where we stay flat, waiting for further market structure clues as to the future direction) and then receive the green light to start buying.
