The trends on the market. How to avoid mistakes?
Javier Castillo Guillén | Feb 15, 2021 12:35
We all know we must generally trade in favour of the trends in the market, as much as possible. This is a statement you will hear from anyone with experience in the sector.
When we decide to trade, we seek to understand in what context we are and try to take advantage of it. Swimming against the trend is usually tedious and not very fruitful for general investors. Except for those of course, specialized in the contrarian style.
Under my point of view, there are two main mistakes when it comes to trading assets in trend:
- Trade against certain trends because we think the asset has fallen a lot, or the value has risen a lot. Without any other analysis behind.
- After analysing the trend properly, failing on the entry point.
What Are Stock Market Trends?/h2 h1 We understand a trend in the market as a succession of prices that move in one direction (bullish or bearish). They occur as a result of an imbalance between the supply and demand of the asset to be studied. In order to be considered a trend, a constant succession of increasing lows and highs (Bullish) or decreasing lows and highs (Bearish) must be given. The more points on the trend zone, the stronger we can consider that zone.
Lateral Range/h1 h1 /h1 h2 A lateral range it is a movement of prices that DO NOT have a succession of increasing or decreasing highs or lows. At the theoretical level, it cannot be considered a trend. It occurs when prices do not establish increasing or decreasing sequences. Its breakout is one of the most traded patterns in technical analysis. This is because a Phase 2 trend could start.
Phases of Stock Market Trends/h2 h1 There are several authors who develop the study of market trends. Most divide them into 3-4 phases. To know how to trade these elements correctly, in first place we must know what phases they comprise. This fact will allow us to know at what moment of the movement we are currently./h1 h2 Accumulation Phase or Phase 1/h2 h1
We find a value that after a bullish or bearish movement, is moving laterally. On a practical level, we usually observe price stabilizations, floors, supports, absorption patterns (price-volume), figures (triangles, H&S), decrease in volume compared to the previous bullish or bearish movement, it is convenient to observe divergences in oscillators such as MACD, RSI to analyze the possible direction of the movement.
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These factors, added to a lateralization of the price, can indicate that we are facing phase 1 of a trend. We don’t know yet if it will be bullish or bearish.
What Dangers Are There In The Accumulation Phase?
At an operational level, the main problem we find here is trying to enter the operation “too early”. If we did, instead of operating a trend, we would still be doing the following:/h1
- A contrarian trading. Operating against the market.
- Entering a “weak” value what can lateralize for an indefinite time and ruin our investment horizon, thus falling into an opportunity cost. Determinate investment hypothesis is key
Participation or Phase 2
In the second phase, the value begins to be attractive to the public that follows the sector and the most agile investors. The value begins to move and there is more and more interest on the direction (therefore the price will move faster) and the lateral range ends up breaking.
Starting the succession of rising highs and lows for the uptrend, or vice versa for the bearish one. As well we could consider chartist patterns such reverse head & shoulders, triangles, etc.
We will find price-volume patterns that must be taken into account and that indicate an acceleration movement when the price goes in your favour.
The key aspect to consider will be the optimal entry point and stop loss and risk rewrad ratio. Detecting it in time is essential for the success of the operation.
What Dangers Are There In The Participation Phase?
From my point of view, there are two main problems:
- The entry point. This has to be done either at the break of the lateral range, or at the pull back. Generally to take into consideration the next point.
- Risk-Reward Ratio. Sometimes the technical stop point can be so far from the entry price that it does not compensate in our investment. Therefore, either we enter at the right price, with proper risk-reward or we could consider not to enter.
Distribution phase or final
Here the well-known (Fear Of Missing Out, or FOMO) occurs, which is summarized in trading with greed and anxiety. Wanting to enter a value at all costs because it escapes us. Instead of having waited for it at the right time (Breaking of the lateral range in phase 1), we went out to “hunt” the price. By doing so there are failures in the management of stops, entry volumes and obviously the entry point with its corresponding risk-reward ratio. We have not been strict in our investment plan.
If it does not continue to move, corrections or trend changes appear. It is interesting at these points to establish Fibonacci levels, work with MACD or RSI, to see if the trend slows down to acceptable levels and continues, or we are approaching a reversal in trend.
What dangers can we find in the distribution phase?
Entering this phase is the one that represents the most danger due to many factors. It should not be emphasized that if we do not enter the correct phase 1 breakout moment here, you no longer have to buy until next opportunity comes via technical analysis.
- The asset can become very volatile.
- We can find lateralisations on the resistance (or support) levels of the movement. This can lead to the start of a continuation of the trend, a correction or a trend reversal.
With this post, I do not pretend by any means that you think that this is all that is behind a trend, there are more factors to take into account. However, I do want you to be aware of the main mistakes that are made when operating them. Knowing them will help you in the safety of your trading.
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Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
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