Trend Trading Guidelines, Part II
This lesson will cover the following
- General thoughts on trend trading
- Discipline and emotions
- Some common mistakes
In part one of the current article we made you familiar with some of the suitable entry points when it comes to trending markets. Weve said numerous times throughout our training course that with-trend positioning carries less risk. However, it is not risk-free and many traders continue to lose money even when they dont bet against the market.
Discipline, and the trading psychology as a whole, is the foundation of trading. Becoming as much resilient as possible to emotions during trading is key to success, because it allows you to not abandon your predetermined trading strategy and go in pursuit of different profit targets out of greed in the course of trading.
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Many traders lose a lot of money exactly for that reason. Before entering a position, a trader should know whether he is looking to scalp or go for a swing and then stick to that choice during the trade session.
Scalps are high-probability trades that require scalpers to be right at least 70% of the time in order to be profitable in the long-term, something which only few could achieve. Meanwhile, swing trading is likely to be successful in less than 50% of the time, but the lower win-ratio is offset by a larger profit. Therefore swing trades are much more suitable for beginner traders. One of the main problems when it comes to these strategies is shifting from one to another in the course of trading based solely on emotions.
A less experienced trader is prone to emotional swings after a series of bad trades and respectively a series of winning trades, or a single huge win or loss. This will often cause irrational shifts from swing into scalp trades and vice versa.
For example, if a trader just profited from a scalp, but shortly after he closed his position the market entered a strong bull trend and he missed on a very tempting swing trade, he might decide that his next scalp should be aimed at a higher price target, instead of just a regular scalp. As he enters that scalp and decides not to exit at the usual profit target and go for a swing trade, the market can reverse a few minutes later and hit his protective stop at a loss.
The opposite mistake can be made as well. If a trader loses money on two or three consecutive swing trades, he might get overwhelmed with fear, causing him to scalp out earlier on his next swing trade and miss on a possible wide price movement, on which swing traders typically rely to make up for the previous losses. If these traders dont hold on to their winning swing trades for long enough, they wont be able to offset the other 50%-60% of trades (or more) that they got previously wrong.
Scalping is high-frequency trading and requires the traders full attention for an extended period of time – something which not all can achieve. Because scalping relies on a very high rate of success, scalpers must be able to clearly distinguish very short scenarios with a 70-80% chance of success from those with 50% chance of success that are inappropriate. And because most traders are unable to do that fast enough in real time, scalping should not be practiced by inexperienced traders.
Swing trading on the other hand gives traders the choice to either enter a whole position at once, or divide it in several smaller positions using the scaling in technique. Logically, upon reaching his profit target, the trader can close his entire position, or he can scale out of the trade, allowing him to benefit further, if the market continues to move in the previous direction.
Common mistake with protective stops
All traders know they must use a protective stop in order to limit their risk exposition, and the experienced traders additionally tighten their stop loss as the market moves in their favor. Some market players however make a mistake which forces them out of the market.
We know that during a trend, the price marks trending highs and lows. During a bullish trend, every time when the market hits a new high, traders should move their stop to several pips below the most recent low. This is because, as the new high is hit, many market players will exit their long positions to lock in profits, thus they sell and effectively push the market down. Because the pullback often extends below the original entry price, traders who have tightened their trailing stop to the breakeven point will be kicked out of the market. This is why it should be several pips below that level. As the price later rebounds and continues with its upward movement, traders would either move their stops below the low of the pullback or at their entry price.
Not so easy
But being easier to succeed at compared to scalp trades does not make swing trades easy in general. Because they are low-probability trades, in real time they are not so clearly seen as setups and tend to force traders to wait.
As we know, a new trend begins after the previous trend reverses or after a breakout from a trading range. However, because most of the real trend reversals begin with a reversal bar after a strong climactic spike, many of the less-experienced traders will think that the old trend has not come to an end and wont risk going against it. Moreover, if they had experienced some counter-trend losses earlier in the day, this would additionally discourage them to trust that reversal bar, causing them to miss an early entry in the newly forming trend.
And so they wait for a pullback. However, because pullbacks are started with a minor reversal, some novice traders will fear that it might actually be a deeper correction or trend reversal, so they decide to wait more. Trends tend to keep market players away from the market, because their existence relies on forcing traders to chase them for a protracted time. In order for a market movement to be long, it has to be difficult to take (low-probability one), while easy high-probability setups result in very short moves, which are suitable only for a scalp.
But where can you draw the line between a pullback and a trend reversal. Generally, traders consider a trend to still be in effect, if the pullback doesnt exceed 50%-60% of the prices daily range fluctuation. Of course each trader has a different understanding, but as long as the pullback is within his boundaries, then the trader will hold to his position, even if the price has not reversed right after he bought/sold the pullback.
Very often traders who have bought a pullback from a high will hold on to their position, even if the market drops below the low of the signal bar, because they are sure the market will eventually hit a higher high after the pullback. Others will sell, if the price drops below the low of the signal bar and later buy, if they see the confirmation of a strong buy setup (higher high). If they are not quite certain, they might enter a half-size position. Conversely, others might enter with half a position after the signal bar and if the market drops, they can enter with a full size at the lower point, if they see a stronger buy signal.