Identifying Trend Direction

The term "Trade with the trend" or " The Trend is your friend" is often used in the world of trading but many people struggle to identify trend direction. The reason that people struggle to identify trend direction is due to the fact that financial instruments don't move in a straight line and the trend may be different depending on which time frame you viewing price.

To identify a new trend I use dynamic support and resistance as well as trend lines bounces and in both cases we will need to know how to use swing highs and swing lows effectively to call the direction correctly. Swing high or low is when price is moving a certain direction and then pulls back or has a pause before resuming in the direction it was moving in. Below are examples of a swing high and swing low candle formation.

  

A swing high is formed when the high of a price is greater than a given number of highs positioned around it. 

A swing low is created when a low is lower than any  other point over a given time period.

Now that we are able to identify what a swing high and a swing low is we can now apply this to our charts in the following manner. In the below chart we can see how the swing highs and lows rejected or bounced off the EMA also know as the dynamic support and resistance.

In the below diagram a trend can be seen by drawing a line and joining the swing high and lows. In this example the swing lows where joined and now we can clearly identify the trend direction. A trend line is only a trend line if there are 2 or more touches. In the same diagram I left the EMA indicators on the chart so that you can see how the swing lows react almost the same way to the trend line drawn.
 
To draw trend lines I suggest you zoom out into the larger time frames and draw 1 or 2 obvious trend lines on each chart. Example lets say you are working on the 4H chart where a valid price action signal is present and you want to identify the trend. Start by zooming out to the weekly time frame drawing the most obvious trend lines on the chart then work you way on each time frame until you get to the 4H. These trend lines will indicate true valid key levels.

The one thing we will never know is when a new trend starts or finishes therefore we should wait for  market to confirm the new bias. In the case with trend lines if price breaks the trend line we can say that a new trend maybe forming, however a trend line needs 2 or more touches to confirm a new trend is in place. The same could be said about dynamic support and resistance.  In both these cases we can say that the second retracement are always important after a new trend.

Now that we have the tools or methods in identifying a trend, combing this with horizontal support & resistance levels as well as a valid price action signal we can confidently enter the market with a high probability trade.

Trading Key Levels with Price Action

Bare bones trading is the simplest way to trade in the Forex market. So what is bare bones in Forex trading? I believe all that's needed is a Daily chart with price action and no indicators. The question now is how do I identify a valid trade setup with entry and exit points? This is where Horizontal or Key levels come in, which is the“core” component of my trading strategy. In this article I will be discussing how to identify these levels and why it should be a fundamental part of any trading strategy. I will not discuss signals at this point in time as there will be other articles  elaborating on this.

There are two types of horizontal levels, these are know as support and resistance. Support levels are usually below the current price. Support is the price level at which demand is thought to be strong enough to prevent the price from declining further. Support does not always hold and a break below support signals a new willingness to sell. Once support is broken, another support level will have to be established at a lower level. Resistance is the price level at which selling is thought to be strong enough to prevent the price from rising further. Resistance levels are usually above the current price. Resistance does not always hold and a break above resistance signals shows a new willingness to buy. To draw these lines you will have to connect all the highest highs to establish a resistance level and all the lowest lows for support levels (This is a very basic explanation in how to establish support and resistance levels, further research maybe needed to learn how to identify these levels correctly).

Why do I trade off these horizontal levels? Everything starts with horizontal levels and all traders pay attention to these key levels in the market, because they know that these levels are significant and can thus have a strong impact on the direction of price. Below are some of the reasons why and how I could use horizontal levels:

• Helps me define my risk by giving me a price level to place my stop loss 
• Provide me with confluence or confirmation level to trade from
• Helps me define my profit target

How are these Horizontal levels formed? The more I study charts the more I see that price never moves in a straight line. Let me illustrate this through the diagram below, here we can see price is in an upward trend and as it makes new highs it also creates resistance when it falls away from these highs, then as it pulls back the previous high / resistance actually turns into support. Old resistance becomes new support in an uptrend, and in a down trend old support becomes new resistance, also known as swing points.

 

 The way that I take advantage of these horizontal level swing points, is to watch for price action signals forming near them as the market pulls back. Look at the yellow circles in the illustration above, these are the swing points at which I want to watch for obvious price action signals to form. By doing this I'm trading from a point where various confirming signals can be seen within a trending market.

It seems that I can also trade horizontal lines in a range-bound market with price action, this is also known as channels. This normally occurs when the market has not found a upward or downward trend but finds itself in a range where price  often swing between support and resistance. In the illustration below we can see an example of what a range-bound market might look like. When price is obviously bouncing back and forth between a horizontal support and resistance level, we can wait for price to hit one of the boundaries of the range and then wait for price action signals to form there.

 Trading with channels as seen above gives me obvious levels to define my risk and reward. Risk is defined just beyond the trading range high or low from the boundary I'm entering near, and reward is defined near the opposite end of the trading range.

In conclusion horizontal levels are very important in the market, and by combining them with a price action signal allows me to have a very effective trading strategy. Price Action signals will be discussed in future articles.