In part 1 of our series on Reading the Market, we looked at Understanding General Price Action Trading and in part 2 we focused on Short Term Price Action Strategies. In this article, the last in the series, we’ll talk about understanding trend trading.
There are essentially three market states;
This is a period where neither the buyers nor the sellers are dominant and appears on a chart as a sideways movement in price within a broad trading range.
This is a period when the buyers are more dominant than the sellers and the price of the stock is increasing over time. Of course there will be periods of short term price reductions (pull-backs), but generally this provides good conditions for buying opportunities.
This is when the sellers are more dominant and the price of the stock is falling. Buying stocks during a downtrend provides you with a lower probability of success.
This may all sound very simplistic and quite obvious. Our point here is that the state of the market is a key factor in assessing the risk and probability of success through the adoption of trend trading. If you enter a counter-trend trade in an obvious uptrend or downtrend, the risk of the trade failing is much higher than if you enter a trade with the prevailing trend.
With trading in ranges, look to trade off the edges (ie enter short trades off the top, or resistance level of the range and enter long off the bottom, or support level of the range). Again, there is often less risk to trade with the prevailing trend before the range formed (i.e wait for a long entry if the trend preceding the range was up or look to go short if the trend preceding was down).
Trend Trading: The Bottom Line
So when reading the market, you need to learn how to determine the general price movement, analyse the most recent price action for your trading period and then make your trading decision based on what the overall market trend is. If you do this, you are then in a far better position to speculate on the most likely next move in price.
This approach to reading the market doesn’t rely on identifying specific patterns, indicators or complicated formulas. It does, however, require a degree of intuition to analyse the price action and make an informed trading decision. We’re not saying that you shouldn’t use indicators in trading decisions, in fact they can be a great supporting tool. We do believe though, that for long term trading success, the ability to read the market and interpret price action is invaluable.
Key Message: In the rush to identify trading patterns, don’t forget to assess your overall market conditions. Identify if the market is in an uptrend, downtrend or range. Trading with the trend often carries less risk than trading counter-trend. When trading ranges, look to trade off the edges, preferably with the trend preceding the range.
You’ve completed our 3 part Reading the Market series! To further your learning in trading, we recommend the following readings: