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Monday, April 15, 2013

Calm trend trading method

Last week I introduced you to 4 types of market conditions that prevail in any financial market. They are: calm trend, volatile trend, calm range and volatile range. I took time to explain to you the concept of calm range and how you could trade that type of environment. Today I want to continue talking about market conditions and discuss how you can define a calm trend and the way you can trade it. I like this trading system as it keeps you least nervous while trading due to the nature and size of market moves under these specific market conditions. 

Defining calm trend

In a calm trend you would see: a clear breakout from its’ previous range (that’s how it starts) and then orderly movement of price forming higher highs and higher lows continuing from a week to multiple months. You would seldom see very strong counter trend rallies and if you do these would be short lived and market would again form some reversal pattern that would be a unique opportunity for you to jump into a trade and go with the flow. When I started trading Forex in 2004 I saw a lot of these kind of trends in the market. At the time US dollar and Japanese Yen would be in these calm down trends most of the time. 

Ranges before trends

Securities would spend from a few months to half a year in a range and then break it and develop a trend for a month or three. Then another range would form. It was (and is) quite easy to trade these kind of market states. You just enter a buy stop above the highest point of the range and a sell stop below the lowest point of the range and when one of these are broken you go with the market. It is quite difficult to predict market bottoms and tops as well as exact timing when a break or a bottom (top) will occur and therefore you enter a trade when market has already gained some momentum and is going forward with force. So, you might miss the beginning (bottom) and the end of the move (top), but you get the middle and do not forget that the middle is where the market move at its’ peak strength. 

Mechanics of bottoming or topping or how market prepares for big moves

When market bottoms (in a range) are formed you have a lot of choppy price action as those who are driven by inertia of a previous swing (down) are selling the rallies (at least they think these are rallies). However, smart money start going in the market in bottoms accumulating amateurs’ money (those that do not see that the trend is changing). 

I noticed that a calm trend will often develops when market stays for a long time in a range. Five months is often the case. You would also see the narrowing of a range before the thrust up (or down if downtrend starts). This narrowing range is a clear indication of accumulation (or distribution if they are getting ready to push a security down) of positions by smart money and can be an early signal for you to enter a small position in the anticipated direction. So, when the move does occur you already have some profits that would be a good cover for you to open new and bigger positions (or a line of positions) when the strong move finally starts. 

usd/jpy example

We also saw this kind of calm trend in Yen pairs at the end of 2012. There was bearish momentum in Yen since the end of summer, but real acceleration started in the middle of November after Bank of Japan as well as government officials started expressing their policy regarding current state of economy and their wish of weaker Yen as well as stimulation of the market. That’s when calm trend really started and continued till February of 2013 (and looks like it still may continue for some time). The best study case for the move is usd/jpy pair. Open a daily chart of the pair and you can see that from June the first (2012) till November the 16th (2012) the pair was in a big range after a ‘volatile trend’ down (from the middle of March to June of the same year). If you know anything about chart patterns you will also see that during five and a half time period Dollar/Yen pair an inverted head and shoulders pattern. The left shoulder (the lowest low of it) was made on the 1st of June (2012), the head on the 13th of August (2013) and the right shoulder (the lowest low of it) on the 9th of November (2012). You can also see that two very important resistance points were formed during that period. The first one on the 24th of June when price hit 80.61 level and on the 2nd of November when price hit 80.67 level. 

Now, looking at the left side of the pattern (left side of the head) we still see quite strong power of bears. usd/jpy rallies were met by severe selling that could be seen on daily bearish candles (25th of June, 22nd of August, 7th of September and 19th of September (last important bears fight). So, any time price rose to resistance US dollar bears did come in and started selling. The last attempt on the 19th of September was short lived and bears failed to form lower low. From that time on we saw an increasing bull power and weakening power of bears. The right side of the inverted head and shoulders pattern (starting from the head) is dominated by the bulls. Any attempt of bears to push the price lower was met by much stronger bulls power that can be seen on daily bullish candles (28th of September, 11th of October, 30th of October and 14th of November). 


Seeing this happening the only logical conclusion was to plan your long entries above the two resistance points (mentioned earlier). You can clearly see that it was really an excellent entry point and after it was breached a calm trend developed. Higher highs and higher lows with short consolidation patterns along the way show the strength on the tendency. 

Now, when these nice moves happen most traders make most of their money. You must be ready to squeeze out of the market as much as you can and you do it by opening additional positions. One of the ways is to enter extra buy stop orders above these short consolidation patterns (‘peaks’ in the chart). You can also wait for a reversal pattern on hourly charts and get better prices, but the way to add to a position in this way is a little more complicated (hope to explain it in my future posts). 


A classical method of placing stops in this kind of trend is to place a stop below the low of the day (if market breaks upwards) when a break occurs. You place the stop above the high of the day when the break downwards occurs. In our situation, the resistance that we anticipated to be was at 80.70 level. It was broken on the 15th of November. It means we have to place our stop below the low of the day, which is 80.12. We can slightly modify the level by placing it 5-10 pips lower, just if the market comes back to ‘kiss’ the break point. 

What about line of position or other positions that you open as the market continues moving upward? Firstly, you wait for retracements (counter trend rallies) and then reversal patterns to enter the trend with extra positions. You then place stops below the valleys (in an uptrend) and above the peaks in the downtrend. 


One classical way of calculating where you should exit your position is to calculate the high and low of the previous range. That would be the minimum distance that the trend will cover. The previous range was rather small, only 350 pips. So, you could have exited part of your position at around 84.20 level and let the other positions ride. 

Price action determines exit levels best

The best way to exit the market is to watch price action. As the calm trend progresses you will see more and more counter trend moves. In this case, it means that more and more bears are stepping in. At some point you will see a major correction rally (read about it in my post: Fortunes are made when trends change), then an attempt to go beyond previous high. If there is a failure you can assume that the trend really changed and you should exit your position and wait for a real reversal as well as the best points to enter a new developing trend or trade a developing range (calm or volatile). Looking at the current price action we see that the pair was able to make higher highs and this tells us that the trend isn’t over yet. So, if you are very patient and determined to trade long term trends this calm trend would have been an excellent opportunity to make nice cash. 

Fundamentals still matter

We know that this long and strong move was inspired by fundamentals, basically verbal financial policy of BOJ and the government of Japan position regarding stimulation of Japan’s economy. On the 4th of April they confirmed their financial policy during interest rate decision meeting and took aggressive action to stimulate the economy. You can clearly see how the market reacted. usd/jpy pair moved more than six hundred pips in six days. Pretty big rally, huh? So, it is good to know when and what fundamentals come out and then watch how market reacts to the data. 


In order to be able to trade any financial markets one must be able to identify specific market conditions that the market is in at a given period of time. Four basic market states and knowledge how the mechanics of each one of them works enables you to trade any financial market efficiently. Today you read how to identify, prepare and trade a calm trend market and make profits as a result.

Trading financial markets carries a high level of risk, and may not be suitable for all investors. All information on the blog is of educational nature and cannot be considered as advice, recommendation or signals to trade in any financial markets.