There is a strong reason why so many articles have been written about trading “with the trend.” This is because it may be the most important thing you can do to put the odds in your favor when it comes to trading success.
Yet many traders either forget this trading wisdom or do not feel it is important. And so follows that most traders fail.
One of the biggest complaints I have read about “trading with the trend” is that it is all relative. That is true! It depends on several factors, such as the time frame of the chart you are analysing, the time frame you wish to trade within, and what you are doing (method) to determine the trend.
Some have suggested that determining the trend is “subjective.” This is not correct.
The definition of a trend is pretty clear and objective.
A “Bull” trend is where you have higher swing bottoms. A “Bear” trend is where you have lower swing tops and bottoms.
Therefore, the only thing left here is to explain what a ‘swing’ bottom or top happens to be.
In the most simple of terms, a ‘swing’ simply refers to the change of direction of the swing line. If the swing line that is moving from new low to new low is moved to a new high, that last lower-low is considered a “swing bottom.” If the swing line that is moving from new high to new high is moved to a new low, that last higher-high is considered a “swing top.”
The rules for moving the swing line is simple. First, you must decide whether it will be based on 1-bar, 2-bars or 3-bars. The 1-bar swing reflects the more short-term swings, where the 2-bar and 3-bar are used for the longer-term swings that occur less frequent than the 1-bar.
So say that we want to isolate the 1-bar swings. Start from any significant market bottom or top. In this example, we will start from a major bottom.
Now, once a price bar forms a higher-high than the price bar preceding it, we call that a higher-high bar. Draw the swing line from the major bottom low to the new higher-high. Now, for every high that is higher than the high where the line currently sits, you would move the line up to that new higher-high. But if a price bar comes along that makes a lower-low than the preceding bar low, the line must ‘swing’ down from that last higher-high to that low. For each low that forms lower than the low where the line currently sits, the swing line moves down to that new lower-low, until such time that a price bar makes a higher-high again and the line ‘swings’ up to that high.
Every bar where the line was at the low when it swung up to a new high is called a “swing bottom.” Every bar where the line was at the high when it swung down to a new low is called a “swing top.”
There will be times when a bar makes both a higher-high and lower-low. These are called “outside” bars. To deal with these, we must determine which formed first during the trading day; the new lower-low or new higher-high.
If early in the day it formed the lower-low first, then before the close it formed the higher-high, the line should be moved first to the lower-low and then to the higher-high of the outside bar. If it was the other way around, the move the line accordingly. This method would not apply for the 2-bar or 3-bar swing approach, however.
Comparing these swing tops and bottoms to previous tops and bottoms, we can determine the trend for whatever time frame we are analysing. If we see a series of higher swing bottoms, the trend is “bullish.” If we see a series of lower swing tops and lower swing bottoms, it is “bearish.” It is possible for a swing bottom to form lower than the previous in a bull trend and still be considered a bull trend. But if it forms lower than the last two, the trend has likely changed. The reverse is true for bear trends. If a swing top forms higher than the last but not last two, it can still be a bear trend. But if it forms higher than two previous, the trend may be changing.
The rules for 2-bar and 3-bar swings require just a minor adjustment. Rather than moving up to each new higher-high or down to each new lower-low, you must reach a count of 2 (for 2-bar) or 3 (for 3-bar) before advancing the swing line.
So if starting from a bottom, the line would only move up to the highest-high after the second higher-high has formed. Then it would move up to each new higher-high for as long as no lower-low with a count of 2 forms. If the swing line is moving up when a lower-low forms, that is a count of 1. If after this a new higher-high (higher than the high where the line is sitting) forms, the line moves up to that new high and the lower-low count is reset to zero again. But if no higher-high (where the line is sitting) forms when a new lower-low forms that makes the count of 2, the line swings down from the high to that new lower-low and the higher-high count is reset to zero. The line then just moves down to each new lower-low from there until a higher-high with a count of 2 moves the line back up again.
W. D. Gann referred to this as his “Trend-Line Indicator” for determining the trend objectively.
When trading with the trend, you can use these swings as price locations to adjust your trailing stops. If going LONG in a bull trend, each new higher swing bottom is a price level where a stop-loss could be moved just below of to protect accumulated profits. If SHORT in a bear trend, each lower swing top presents a price level where a stop-loss could be moved just above.
Because price tends to move in the direction of the trend longer than in counter-trend moves, it provides the highest odds of success. You now have a simple method for determining the trend along with a simple stop-loss strategy. Use it alone or with other methods you have found useful.