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Now we are developing the tenets of good trading. We are trading with the trend and locking in profits. But in that case, how do we know the trend might be ending?

As stated, an uptrend is intact until the previous downwave in the uptrend is surpassed. A downtrend is intact until the previous upwave is surpassed. We will use the lowest low while the volatility indicator signals an uptrend for our low point. This is just an alert that possibly the trend might change. We would still take the next trade in the direction of trend (in a confirmed uptrend, we take all upwaves, and in a downtrend, all downwaves).

Our next step is to confirm whether the trend has ended. This is confirmed on our next wave. If we are in an uptrend, and if our last downwave went below the prior downwave, we are on alert. If the next upwave surpasses the prior upwave, our trend is intact and our alert turned off.

In Figure 3, which shows a chart of the Swiss franc, we went short in April 1997 and closed the position in June 1997 with a nice profit. Because the highs of the prior upwave were not surpassed, we know we are still in a downtrend and went short again in June 1997. This trade did not work, however, and the next blue upwave surpassed the prior blue upwave; thus, we are on alert the trend might be changing. We went short again in September 1997.

MULTIPLE TIME FRAMES

To enhance our performance in this strategy, we can use a dual time frame. We look to a higher time frame to identify the trend and only want to trade in that direction. In Figure 4, we can see we are in a downtrend as well as a downwave on the five-minute chart of the Standard & Poor’s 500 index, so we only look to take trades to the short side on the one-minute chart (Figure 5). We are short from approximately 11:30 in the morning to the close. The trader looks to the lower time frame to actually find the trades in the same direction of the higher time frame.

On the one-minute chart, we are looking to trade only from the short side because the five-minute bars are in a downtrend from a little after noon. In our diagram, we see we had three trades. Two of them worked and in the one that didn’t, our loss was relatively small. If one-minute bars are too short of a time frame, then consider trading five-minute bars; the trader would look at the 15-minute chart to determine the trend.

For example, if on the 15-minute chart he is in an uptrend and identifies blue upwaves, he would go down to his fiveminute chart, identify a red downwave and prepare a buy-stop to pull him in the market if an upwave becomes present. The same applies just in reverse for going short.

The time frames can be anything from a 10-tick or 25-tick to a daily and a weekly. There must be substantial differences between the two frames. Some ideas would be 15-minute versus 60-minute, daily versus weekly, weekly versus monthly. Neither we nor anyone else has developed a Holy Grail system or an infallible trend indicator, but through diversification of noncorrelated markets and also a diversification of time frames, the probability of success can be obtained.

SUMMARY

Trading should be a simple application of a trend indicator, such as the volatility indicator, and a trading plan with rules. To enhance your profitability, consider using two different time frames, one for the trend and a lower time frame to signal your trades.