Trading trends can be tricky as their essence boils down to analyzing the momentum of an asset, and in a volatile crypto environment, it can be even trickier.
Remember, if you are not yet confident implementing your own strategies, feel free to use our thoroughly backtested trading bots while practicing strategy execution.
As you may know, Bitcoin prices have just recently broken out of their range. If this situation is confirmed, we could be starting a new uptrend.
We often hear or read that prices are trending up or down, but what does that really mean? How do you recognize a trend and especially how do you trade a trend following system?
Have you ever asked yourself this question? Well, that’s just what today’s article is about. Let’s get started!
What is a trend?
Before knowing how to recognize them and take advantage of them, let’s first try to understand what a price trend is. It is important to know that there are several market cycles, and each cycle is composed of sub-cycles, which are themselves composed of sub-cycles.
We will discuss the different time frames for trends later in this article, but for now let’s imagine the market cycles in the simplest way:
First comes an uptrend, then comes a consolidation or range and finally a downtrend. This is a simplistic way of imagining market behaviour but it makes it easier to understand.
There have been a large number of studies focusing on analyzing the behaviour of prices to predict future movements. These attempts have been more or less successful but we have nevertheless managed to “prove” that prices evolve around their average and tend to return to it when it deviates too much.
The first lesson we can draw from this is that prices certainly do not evolve in straight lines but rather in a succession of upward and downward phases. In order to have an uptrend, prices need to make a new high, for instance – after a break of resistance. Then, the retracement must register a low point that is higher than the previous low point.
As soon as this is the case, we can consider ourselves in an uptrend. We can see an example of higher high and higher low on the Ethereum chart below.
The Trading Range
A trading range is a basic principle of chart analysis and comes down to what we call – a price range. A range is the difference in price between supply and demand. A range has peaks and troughs held by horizontal support and resistance in a channel that prevents it from moving up or down for some time. The market is therefore stagnant.
It would be far too simple to have only trend periods that we could then recognize with their high and low points. A trading range often occurs after a pronounced trend and can last up to several months before prices manage to break their support or resistance.
An example of range trading can be seen in the chart below. We talked about it last week in this article (insert article link) it is better to play the first retest of an already established support or resistance level. As we can see, if you had decided to open a short position on the second retest, it would have certainly been liquidated.
As we can see on the chart below, a downtrend is the exact opposite of a bearish trend, a succession of lower and lower lows and a succession of lower and lower highs.
We have now defined the main market states, so now it’s time to take advantage of them. A trend-following system is a trading strategy that will try to catch a trend and stay in the trade as long as possible, ideally until the trend ends.
This type of strategy is one of the easiest to implement but its manual application can cause some concerns in terms of emotional management. Trend following, if you don’t filter the signals, can have a fairly high drawdown, around 30%.
Nevertheless, even if not filtering your strategy can bring a large number of false signals, trend following remains profitable in the long term, as the potential gains can be significant and completely erase a period of losses.
How can this be done in practice?
There are many ways to trade a trend, and we will discuss some key indicators that will help you to see more clearly and filter out some of the false signals.
The moving average
The moving average is the reference indicator when talking about a trend-following system. The easiest way to use it is to analyze the behaviour of prices in relation to its average. If the prices are above their average, this is already a good sign that they are continuing to rise. So we use the average as a filter (Buy position only if above)
The SuperTrend is an excellent trend indicator and can be used in different ways: to set stop-losses, to identify support and resistance areas and to get buy or sell signals.
Volume is one of the most relevant indicators in technical analysis. They allow you to judge the strength of a movement. In the context of trend following, they should be used to confirm a breakout from a previous high point. A breakout without volume is likely to be wrong.
The MACD is an oscillator but we can classify it as a trend indicator anyway. It is based on a moving average difference and its use is mainly through crossings. In a trend following system, it can therefore be used to play a return to support (Moving Average or SuperTrend), the MACD must then cross at the same time to provide a strong signal.
The ADX indicator tells you the strength of the current trend and, unlike most indicators, does not give clarity on the direction of the trend. It can therefore be used as a filter.
Long-term VS Short-term trend
The time horizon is very important when talking about trends. At the beginning of this article we discussed market cycles. There is indeed a long term cycle, which takes several years of rise and then fall, all interspersed with the consolidation phase.
However, during a long term bullish phase, there will be inverse price movements, therefore bearish, which will be in fact medium term trends.
The key to success in trading, if you are a beginner, is to be on the side of the underlying trend. You will therefore wait for a medium-term trend reversal in the direction of the long-term trend to enter a position.
Trend following is one of the easiest strategies to implement in the trading world. However, the key to success will again lie in your creativity and rigorous backtesting. Follow your strategy once it is confirmed, and don’t succumb to FOMO! And if you don’t feel confident crafting your own strategies, remember – Superbots trading bots are thoroughly backtested, completely emotionless and capable to execute strategies with perfection.