The Trend is Your Friend, Until the End of a Trend Where Patience Pays Off till The Next Round!
If you’re long enough in the crypto trading sphere, you’ve probably heard about this old saying. Most people know about the first part (The Trend is Your Friend) and forget how it ends (Until the End of a Trend). Don’t make this mistake, because following a trend is as important as knowing where to flip your bias. So, what is this all about?
According to Investopedia, a trend is a general direction of a market or price of an asset. There are multiple methods to identify a trend and I would recommend using at least a couple of them. When you apply different techniques and see how they correlating with each other, it increases the probability of you being right in your analysis.
How can you identify trends with basic instruments?
The simplest tool is the trend line. Here is an example of a trend line at Bitcoin chart from 2019:
This is not the most accurate drawing but still can give you a basic understanding. As you can see Bitcoin was trending upwards and bounced every time after touching this trend line.
Key points here:
- 3 touches make a trend line, not less. You can’t consider a valid trend line if it has only 2 touches.
- You can draw a trend line using bodies or wicks, just be consistent. If you choose wicks, your strategy should imply only wicks.
You can also use candles to identify a trend. Japanese candlesticks have a history of more than 400 years and they are giving information faster than any other indicator. If you want to become a successful trader, you should know how to read them properly. I can talk a lot about different patterns and types of candlesticks, but in this particular case, we need them to identify a trend. We’ve used as an example Bitcoin bull market, now let’s apply them to the bear market of 2018.
The basic definition of a downtrend is a series of lower-highs and lower-lows. Check this chart of Bitcoin for better understanding:
As you can see, selling pressure is strong and the price cannot make a new high. After breaking major support levels, it becomes a resistance, sellers step in and the price of Bitcoin is declining. More than that, price is making lower lows and this is a clear confirmation of a downtrend.
How to identify trends with indicators?
You can also spot a trend with indicators. For example, exponential moving averages (EMAs) are working well for me and I am using them on a daily basis in my trading activity. You can try and test simple moving averages (SMA), the only difference between them is that EMA is more reactive to price action.
Let’s take as an example a recent drop in Bitcoin.
On this picture are present 4 EMAs: 10EMA (purple), 21EMA (blue), 50EMA (white) and 200EMA (red).
EMA strategy for spotting a trend
The most common practice for identifying a trend is to use crosses. If lower period EMAs are crossing up longer period EMAs, this usually indicates an uptrend and vice versa.
So is Bitcoin in a downtrend? We already know when an asset is making lower highs and lower lows, it indicates a downtrend. Right now the chart above meets our criteria, but let’s check it once again from the EMA perspective.
You can spot that 50EMA has crossed 200EMA (this is called “golden cross”) at the start of this month, but now the price has dropped to cross point. Don’t let it confuse you, this is a normal thing, usually, major crosses are tested at least once. Right now price is bouncing on 200EMA and we don’t have a daily candle close below this moving average. 200EMA also has a positive slope.
Regardless of that fact we have a downtrend according to candlestick pattern, all these factors indicate a strong buying opportunity. As you can see, sometimes it is hard to identify a trend, using only one tool.
How can RSI help us to see the trend?
Another great tool is the RSI — Relative Strength Index. Here is an example of the RSI of Bitcoin on a weekly scale:
RSI can be bullish or bearish. When RSI is 60 and above it’s bullish, when it’s 40 and below — it’s bearish. Between 40 and 60 is the neutral zone.
Let’s take a chart above as an example. Every time RSI drops to 40, it bounces back quickly — strong uptrend. The moment when it breaks below 40 and stays there, the bear market starts. Remember, this is a weekly chart and things can take time when you are trading such time frames.
During strong trending moves, RSI can stay in bullish or bearish zones for a long time. That’s why it is better to combine RSI with other indicators, like stochastic, for example.
The basic strategy for this indicator is to open a long position when it makes a cross up and to short when it crosses down. Drawing trend lines also can be useful in this case, it helps you to be more accurate in your analysis.
When combining RSI with stochastic you need to look for conjunction. If stochastic is crossing down, but RSI is strongly bouncing back into bullish zone, it’s probably not the best time to short. The same logic applies to bear markets.
And last, but not least — if you are just starting, do not use lower time frames! Trend is something you can spot only on a global scale; therefore, you should make your analysis on a daily chart or even weekly. This will make your decisions more precise and your life easier.
Why do we need to identify a trend?
Identifying a trend is a very important skill you need to have under your belt. It can be quite difficult if you’re just starting, but it directly affects all your trading decisions.
For example, you’ve longed Bitcoin all the way up to 20k in 2018 and continue to long every drop to support line, ignoring that fact it makes lower highs and lower lows. Now you’re playing the most dangerous game — going against the trend. Your results are dropping, your statistics are negative and you don’t have anybody to blame, except yourself. A lot of accounts were blown by going this way.
Use different trading methods, do not forget about stop-losses and you should be fine in a long term perspective.
Disclaimers: Digital assets are innovative trading products, and prices fluctuate greatly. Please rationally judge your trading ability and make decisions prudently. As always do your own research and trade at your own caution when buying and selling all digital assets within the Huobi ecosystem. Huobi reprinted parts from a third party. Huobi is not responsible for the losses owing to the wrong analysis results made by users using the trend judgment.