How to Spot and Trade Uptrends in Any Market
Trends are a trader's friend, if you know how to spot and trade them
While the phrase "the trend is your friend" is cliche, there is truth to the statement...but only if you understand trends and how to trade them. If you don't understand trends, traders who do will take your money, which you probably won't find friendly at all.
There are uptrends and downtrends. This article will focus on the price structure of an uptrend, what events cause uptrends to reverse, and how to trade an uptrend.
Price Structure of an Uptrend
An uptrend is composed of two types of price waves: impulsive and corrective. If a stock rallies from $10 to $10.50, falls to $10.25 and then rallies to $10.60, each of those three movements is a price wave.
Impulse waves are larger: $10 to $10.50, and $10.25 to $10.60. Corrective waves are smaller: $10.50 to $10.25. This is how trends are created, and how the price makes progress in one direction or the other. If there is an impulse wave up, followed by a corrective (smaller) wave down, then the price has made overall progress to the upside. The price trend continues to advance as long as impulse waves occur to the upside.
The attached chart shows this in action. The line chart of the SGDJPY forex pair shows the price advancing to the upside. The price moves lower, but that wave is smaller than the prior wave higher. An uptrend is, therefore, a sequence of higher highs and higher lows.
Moving from left to right on the chart, the impulse waves each reach a higher price than the last impulse, and the lows of each correction also move up.
See Four Trending Indicators for tools which may aid you in seeing the current trend direction.
What Reverses an Uptrend
If an uptrend is a sequence of higher highs and higher lows--or impulse waves to the upside and smaller corrective waves to the downside--a reversal is when those criteria are violated.
If the price makes a lower high or lower low, that signals the uptrend is in trouble. If an impulse wave occurs to the downside and is followed by a smaller up wave (lower low, lower high), that's a sign the uptrend is in trouble.
Trading requires adapting to new information as it comes available. The price may move into an uptrend, give a signal the uptrend is in trouble, but then revert to an uptrend again. Or the price could move sideways or into a downtrend. In either case, isolating in which direction the impulse waves are moving will give you the trend direction. If up and down impulse waves are the same size, then the price is moving in a range (sideways).
When impulses are to the upside, favor buying on corrections. When impulses are down, favor short selling on corrections.
Trading an Uptrend
Trends occur across all time frames and all assets. They can be viewed and traded on the short-term (tick and one minute charts) and over the long-term (daily, weekly, and monthly charts). While the chart shown is a daily chart, the same concepts apply when looking at a one-minute chart or weekly chart. All that changes is your trading time frame--if viewing a one minute chart trades are taken to capture small trends lasting hours (rare), minutes, or even seconds.
On a weekly chart, traders are seeking trades that could last months or years.
Once an impulse wave occurs to the upside (an upside move larger than the prior down waves) it's possible a new uptrend is starting. Therefore, when a correction develops it likely won't drop all the way down to where the impulse wave started (because corrective waves are smaller). Therefore, we can plan on buying during that corrective wave, based on the assumption that the price will have another impulse wave to the upside.
There are multiple techniques for entering a trade during a corrective wave. Fibonacci retracement levels aid in isolating areas where the correction could stop and reverse--a great entry point. Another method, which can be used in conjunction with Fibonacci levels or other technical indicators, is to wait for the correction to stop falling, move sideways and then move back in the trending direction.
That signals the correction may be over, and the next impulse wave is beginning. Examples of this strategy are provided in How to Day Trade Stocks.
Every trade requires a stop loss to manage risk (see Where to Place a Stop Loss), and an exit strategy for taking profit. During an uptrend, the assumption is that the price will make a new high...until it doesn't. Therefore a target--an order to exit your trade with a profit--is placed near the former high. In a very strong trend (very big impulse waves) the target is placed above the prior high. In a weak uptrend (impulse waves barely bigger than corrections) the target is placed just below the prior high.
Final Word on Uptrends
An uptrend occurs when larger waves (impulses) occur to the upside, and smaller waves (corrections) occur to the downside. During uptrends consider buying during the correction--technical tools and strategies help isolate when a correction may be ending. Utilize a stop loss order to control risk, and also plan for how to exit a profit trade, likely using a price target.