Trend Trading: Reading the Momentum

Trend Trading: Reading the Momentum

Trend Trading: Reading the Momentum

Trend trading involves a longer time horizon, requiring sufficient capital for that longer period. It can be an effective tool especially when combined with volume analysis, gaining deeper insight into traders’ behavior.

Trend trading is a strategy focused on profiting from the main direction of an asset’s momentum in the market cycle. Typically trends can last months, sometimes years. So traders who exploit this strategy need to keep their orders active for long periods of time, but they will not need to spend many hours checking or analyzing markets every day.

In fact, a good practice is to integrate trend trading with volume analysis, which allows you to follow just a few indicators and consider a few volume levels.

With volume being an objective and measurable indicator, this combination works for any kind of market, including cryptocurrency markets.

What is Trend Trading?

We can divide market cycles into two major phases: one going upwards and the other moving downwards. 

In trend trading, you should go long when the upward trend is about to begin; you should go short when the market reaches its top. 

To identify a trend, you can draw a line – the trendline – that links the highs (in downtrends) or the lows (in uptrends) of price movements: the higher the number of points you manage to link, the stronger the trend

What is Volume Analysis?

Volume is the number of assets traded in a given time period.

While most of the indicators available for technical analysis have a certain degree of subjectivity, volume is objective and measurable.

Volume analysis is a branch of technical analysis: volume analysts study the relationship between volume and price changes.

The Role of Volume Analysis

As we know, in general, a new trend develops after market lateralization. During this period, informed traders and investors add to their positions to accumulate and further increase their capital. This accumulation will result in a peak in volume. 

Consider that when we talk about volume, we need to see it in relative terms, and good historical analysis, different for each market, should be done. You can easily visualize volume movements by using a Volume Moving Average (VMA). Also, in this case, the best practice is to customize parameters in order to spot the peculiarities of each market. 

It is not unusual that when a new uptrend is about to begin, we witness a peak in volume not mirrored by the change in price. That is, even if the volume increases considerably, the price change is not so impressive.

This happens because usually lateralization periods are characterized by uncertainty. While strong hands accumulate, weak hands push the price down by selling, just to recover at least part of their previous unsuccessful trades.

This kind of tension tells us that the rise is about to begin, because strong hands demonstrate — through the positive volume peak — that they are ready to be in the game.

BTC price, July 2017 - Jan 2018. Source: TradingViewBTC price, July 2017 – Jan 2018. Source: TradingView

Let’s look at the image above to analyze a crypto market: the chart shows Bitcoin’s price in US dollars from July 2017 to January 2018. You can also see buying and selling volume bars and a 20-day VMA.

This image shows not only the function of volume in trend trading but also the fact that this particular strategy exploits price movements that cover several months or even years.

Buying volume starts getting higher in middle July — higher than the average and higher than the selling volume. The uptrend has begun, even if we cannot see an impressive price rise. The peak is in September: even if we go long now, we can make good profits.

In November something changes: the peak in selling volume is still not higher than the last peak in buying volume, so the second selling peak needs further attention.

Buyers recover very soon, we can keep our long position, but we may realize that we are in front of an extended market and the trend is about to end.

The confirmation arrives at the end of December: the third peak of selling volume is higher than the previous peaks, and the significant price change confirms the downtrend.

Even if you want to wait for this confirmation to sell or you bought at the second peak of the buying volume, your profits will still amount to a good 256%.

Essentially, volume offers insight into the behavior of traders. It is a powerful instrument that can be used for any market, including cryptocurrencies, to understand the thinking behind the investments of market participants around the world. 

By no means is analyzing volume easy, precisely because you need to consider traders’ intentions. In general, a healthy trend is one in which price rises along with a rise in buying volume and decreases with a rising selling volume. 

When this does not happen, you need to evaluate each candlestick and especially shadows, to understand who’s stronger between buyers and sellers.

Fibonacci and Trend Trading

Fibonacci levels are always helpful in establishing when to invest and when to reverse our positions.

In swing trading, we need to pay attention to many levels, because this strategy consists in following each minor price wave. In trend trading, the most common levels at which the top is reached are 161.8% and 261.8%. In the case of extended markets, the most common Fibonacci levels are 323.6%, 361.8%, or 423.6%. 

Generally, a top should be indicated by another peak in volume, but in this case, it consists of selling volume. As always, we need to consider volume in relative terms.

When it comes to Fibonacci retracements, the most common are 23.6%, 38.2%, 50%, 61.8%, 78.6%, 85.4% and 100%. In crypto markets, a common retracement level is 85.4%.

Trend Trading vs. Swing Trading

Trend trading may look similar to swing trading, but indeed there are enough differences to consider them two distinct strategies. 

Swing trading takes into account minor fluctuations. It requires more work and attention since you need to spot the start and end of each price wave. For this reason, this strategy can cover a period anywhere from a few days to several months. 

Trend trading requires less work. It consists of following price movements from the start of a new uptrend to its top, and vice versa. So, with this strategy, you do not consider volatility and price waves; you need to reverse your positions only when a top or a bottom is reached. 

Final Thoughts

As you can see, trend trading has both pros and cons. It can allow you to make higher profits if compared with other trading strategies. It also takes less time in analyzing charts. Without the need to follow market volatility, you will avoid noise and impulsive decisions.

But this strategy only fits the needs of patient traders and of those traders who don’t need to take their profits regularly. Trend trading involves a longer time horizon and will not work for those who do not have enough capital to keep orders active for months or years.

Every trader should choose a strategy that fits their needs. Of course, volume analysis in trend trading can help in deciding when to go long or short. However, you should always rely on your analysis and perform a different one for each market.

 

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