Further Talk on Trend Trading Guidelines

In part one of the current article, we familiarised you with some suitable entry points in trending markets. We have 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 do not bet against the market.

Discipline, and trading psychology as a whole, are the foundation of trading. Being as resilient as possible to emotions during trading is key to success, because it allows you to stick to your predetermined trading strategy instead of pursuing different profit targets out of greed while trading.

Many traders lose a lot of money exactly for this 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 trading 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 that only a few can achieve. Meanwhile, swing trading is likely to be successful less than 50% of the time, but the lower win ratio is offset by larger profits. Therefore, swing trades are much more suitable for beginner traders. One of the main problems with these strategies is shifting from one to another during trading based solely on emotions.

A less-experienced trader is prone to emotional swings after a series of losing trades and, conversely, 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 has just profited from a scalp but, shortly after he closed his position, the market enters a strong bull trend and he misses out on a very tempting swing trade, he might decide that his next scalp should aim for a higher price target rather than just a regular scalp. If he enters that scalp trade and decides not to exit at the usual profit target but instead go for a swing trade, the market may reverse a few minutes later and hit his protective stop, resulting in a loss.

The opposite mistake can also occur. If a trader loses money on two or three consecutive swing trades, he might become overwhelmed with fear, causing him to scalp out earlier on his next swing trade and miss out on a possible large price movement, which swing traders typically rely on to make up for previous losses. If these traders do not hold on to their winning swing trades for long enough, they will not be able to offset the other 50-60% of trades (or more) that they previously got wrong.

Scalping is high-frequency trading and requires the trader’s full attention for an extended period of time – something not everyone 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 a 50% chance that are inappropriate. And because most traders are unable to do that fast enough in real time, scalping should not be practised by inexperienced traders.

Swing trading, on the other hand, gives traders the choice to either enter a whole position at once or divide it into 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 to limit their risk exposure, and experienced traders additionally tighten their stop loss as the market moves in their favour. Some market players, however, make a mistake that 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 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, effectively pushing the market down. Because the pullback often extends below the original entry price, traders who have tightened their trailing stop to the break-even 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 its upward movement, traders will either move their stops below the low of the pullback or to their entry price.

Not so easy

However, although swing trades are easier to succeed at than scalp trades, they are not easy in general. Because they are low-probability trades, in real time they are not 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 real trend reversals begin with a reversal bar after a strong climactic spike, many less-experienced traders will think that the old trend has not come to an end and will not risk going against it. Moreover, if they have experienced some counter-trend losses earlier in the day, this would further discourage them from trusting 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 start 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 longer. 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 last, it has to be difficult to take (a low-probability one), whereas easy, high-probability setups result in very short moves, which are suitable only for a scalp.

Difference

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 does not exceed 50-60% of the price’s daily range. Of course, each trader has a different understanding, but as long as the pullback is within their boundaries, the trader will hold on to his position, even if the price has not reversed immediately after he bought or 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.