I occasionally get email requests asking how I define the trend, so to save on future email replies here’s the short answer…
It seems that perhaps many people assume I use an EMA, given that the charts shown in my newsletter typically display an EMA(20). That’s not my trend definition though.
I use fairly standard definitions.
- An uptrend is a sequence of higher swing highs and higher swing lows.
- A downtrend is a sequence of lower swing highs and lower swing lows.
So, let’s look quickly at how this works.
A swing high is simply any turning point where rising price changes to falling price. I define a swing high (SH) as a price bar high, preceded by two lower highs (LH) and followed by two lower highs (LH), as per the following diagram:
The Swing High is candle C. All other candles reference this one.
- Candle A has a high which is LOWER THAN candle C’s high.
- Candle B has a high which is LOWER THAN candle C’s high.
- Candle D has a high which is LOWER THAN candle C’s high.
- Candle E has a high which is LOWER THAN candle C’s high.
Likewise for the swing low.
A swing low is simply any turning point where falling price changes to rising price. I define a swing low (SL) as a price bar low, preceded by two higher lows (HL) and followed by two higher lows (HL), as per the following diagram:
The Swing Low is candle C. All other candles reference this one.
- Candle A has a low which is HIGHER THAN candle C’s low .
- Candle B has a low which is HIGHER THAN candle C’s low .
- Candle D has a low which is HIGHER THAN candle C’s low .
- Candle E has a low which is HIGHER THAN candle C’s low .
An uptrend is then a sequence of higher swing highs and higher swing lows, as seen on the left side of the following chart. And a downtrend is a sequence of lower swing lows and lower swing highs, as seen on the right side. The swing highs are identified by green dashes. The swing lows are identified by yellow dashes.
There’s a little more to it, which will be covered in future articles (or in much more detail in the upcoming ebook), such as where exactly I define the change of trend, what happens when we have matching price bar highs or lows, and when and how I define a market as trending sideways rather than up or down.
But for now the key point is that there’s no secret trend identification method. I use a very standard trend definition – HH/HL and LH/LL.
So, why the EMA on my charts if it’s not for trend?
The EMA is not actually needed as all my analysis can be seen though price action alone. It is there simply because it can provide a quick visual interpretation that’s close enough for much of the price action analysis that I conduct, including trend, momentum and volatility.
Of course, it could easily be used as your sole trend indicator, if you preferred. In many respects, it’s simpler. As you’ll see from the following chart, the two approaches give much the same result…
The fact is, it doesn’t really matter what definition you use, as long as your method of defining trend closely follows the price action in the timeframe within which you’re trading.
The reason it doesn’t matter how you define the trend is…
No Trend Definition is Perfect!
No matter how you define it, there will ALWAYS be a pullback that goes JUST far enough to trigger a change of trend, before then reversing again and resuming movement in the original direction. ALWAYS.
The trend is not your friend. Or if it is, it’s the kind of friend that talks about you behind your back.
You’ll see below that the HH/HL definition for uptrend broke down at point A, whereas using the slope of the EMA for downtrend broke down at point B.
This is where you need to be learn how to read the price action. Don’t automatically assume that a breakdown of trend (in accordance with your definition) implies a change of trend. Observe how price reacts at the change of trend location. Area A for example broke the previous swing low twice, but in both cases was not able to hold lower prices, closing above the breakout point. Candlestick fans will recognise two hammers. Trapped trader pattern fans will recognise a great three-swing retrace.
Failure to hold the change of trend provides a great entry back in the original trend direction (regardless of whether or not your definition now considers that counter-trend).