How do you know when the market is trending?

I believe one of the biggest challenges facing traders is trying to correctly identify the market trend. Once you have the trend down then you know whether you want to be a buyer or seller and respond accordingly.

But the catch is knowing when the market is trending and when it isn’t. Getting stuck in a sideways market is never fun, and while sideways markets don’t necessarily mean a losing trade, they can be very difficult to manage to a profit.

Below are two charts stripped of any identifiers. I did that on purpose, because “what” the market is, isn’t nearly as important as what it is doing. So here’s this week’s challenge, look at both charts and tell me, is the market in an uptrend, downtrend or no-trend?

Based on your answer, how would you structure a trade?

Homework Chart 1 - stripped of identifying markers

While most of you picked up that Chart B was sideways market, most of you missed the fact that Chart A was a sideways market also! The last rally on Chart A had many of you thinking the market was in a uptrend when in actual fact it had yet to breakout outside of the trading range that contained the market for the last 100 bars.

This was the point of the exercise: you can’t ignore the left side of the chart. While the last few bars seemed very strong the market is rangebound until it proves it can get out and stay out of the trading range.

Answer to Homework Chart A

Notice the difference? By waiting for the market to breakout and prove it can stay outside of the trading range you can structure a trade to stay on the right side of the market more often than not.

While it’s tempting to try and enter the trade early, in case there’s a big breakout, the truth is that better than 75% of all breakouts fail. But what makes breakout trading so attractive to many traders is that 25% of breakouts that succeed, because they tend to have some big follow through when they work.

The “strong” rally to the top end of the trading range in Chart A is no indication the market will breakout. Very often sellers will reserve their selling efforts until the market gets to the top end of the trading range. This lack of selling before resistance causes the market to accelerate quickly, giving a false sense of momentum, and fooling a lot of breakout traders into trying to buy the market higher on a breakout to new highs.

Of course the reverse is true when the market makes a quick move lower into support, only to find a lot of buyers waiting to buy the market higher on a weak breakout of the lows.

This constant selling on the highs and buying on the lows is what keeps a market rangebound until market conditions are such that more buyers, or sellers, arrive to tip the market higher or lower. Chart B is a good example of “strong” moves higher and lower, into resistance and support, only to get turned around as the bulls and bears dig in and send the market the other way. Can you see them?

So don’t ignore the left side of your chart. It will influence how the market behaves. And remember that until the market can breakout and stay out of a trading range, the market is in a trading range.

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