Mostly, you don’t.
Mechanical trend traders will often use breakout methods to latch onto trends. The idea is that the winners achieved from holding and riding trends out for as long as possible cover all the losses that occur from trying to get into those trends, a.k.a., whipsaw losses. Historically, this approach works.
To avoid whipsaw losses, stop trading – Ed Seykota
Here is the EURUSD, daily chart back in 2013 with 100-period price channels. Each of the circles I have drawn in show valid breakout entries, and all of which were probably losers. You’re -4R down here after this nasty little sequence (and maybe more if you look further back).
Then, through no predictive ability whatsoever, you go short, and you happen to catch a massive trend, efficiently bagging you +10R to +15R.
Where your profits achieved through
a). Your discretion
b). Avoiding losses
c). Holding on to big winners to cover your losses
I’m sure my readers know my pick of the three.
Does this mean that there is no way to identify a trending market?
I believe that there are a few simple tools (yes, with your discretion) that can help.
Let’s paint a picture in high contrast.
A market that isn’t trending:
- This market isn’t going mostly up, or mostly down. It’s mainly going nowhere. You do not require an indicator to tell you this.
- No clear, higher high, lower low pattern.
- Let’s look at the candles themselves now. We see:
a.) Lots of wicks
b.) Alternate colours
A market that is trending:
- This market is going mostly up.
- There is a clear pattern of higher highs, and lower lows.
- To the candles:
a.) The bullish candles are the biggest ones we see.
b.) They don’t give up much on the close (minimal wick showing).
c.) The bullish candles also MOVE price.
- Contrast with the retrace periods. The bears don’t win any ground.
- Retrace periods are slow, take forever, and we see a lot of wicks and candles in alternate colours.
I did say we would use simple tools.