Strategy Smarts Part 2: Trading Trend Days

15 Nov 2023

Welcome to our four-part Strategy Smarts series designed to give you some practical trading templates which build on the concepts outlined in our Day Traders Toolbox and Power Patterns series.

Today’s piece centres around Trend Days; what they are, how to spot them early and most importantly, how to trade them consistently.

The Trend Day: A Day That Can Make or Break Your Month

The day-to-day price action of any market typically includes a lot of noise, which tends to favour taking reversal patterns from key levels. However, every once in a while, a market will move relentlessly in one direction – steamrollering anything in its path and generating outsized profits for trend traders and damaging losses for reversal traders.

A trend day emerges when the daily trading range expands significantly, with the open and close near opposite ends. The initial thirty minutes of trading typically encompass a mere fraction of the day's overall range, with minimal intraday price retracement.

Here’s what a trend day looks like on a 1min candle chart:

Past performance is not a reliable indicator of future results

Note the opening gap, break of the opening range, reluctance to pullback, and rally into the closing bell – all key characteristics of trend days

How to Identify Trend Days Early

Recognising a trend day before it gains full momentum is a skill that separates astute traders from the rest. A few tell-tale signs precede these market-moving days:

Prior Days Range: Trend days tend to follow one or more days with small ranges, building up tension in the market. When the market records a tight daily range, traders should be on high alert for a potential trend day next.

Directional Open: A trend day frequently kicks off with a market gap, without an immediate attempt to fill it. This clear gap serves as a strong signal to watch out for a possible trend day. If no gap exists, traders should see a distinct directional bias during the opening rotation. On trend days, breaching the prior day's high or low often happens swiftly.

Consistent One-Sided Action: Trend days exhibit a noticeable imbalance between market supply and demand, evident early in the trading day through consistently one-sided price action. This implies the market consistently stays on one side of the Volume Weighted Average Price (VWAP), with VWAP clearly moving in one direction. Moreover, there's a general reluctance for prices to retract on trend days.

Examples:

S&P 500 bullish trend day:

Past performance is not a reliable indicator of future results

AAPL bearish trend day:

Past performance is not a reliable indicator of future results

USD/JPY bullish trend day:

Past performance is not a reliable indicator of future results

How to Trade a Trend Day

A breakout strategy, or intraday trend-following method, can best capture a trend day. Wait for the market to tip its hand first by using the early warnings signs in the section above, and then deploy simple, robust and relatively passive trend following techniques to squeeze as much from the trend as possible.

Entry: A key characteristic of trend days is a reluctance to pullback, this means it is usually preferable to enter on breakouts rather than wait for pullbacks when it comes to timing entry. One method that can be used is to simply place a buy stop order to enter above the five-bar high (for bullish trend days).

Stop Placement: Trend days tend to favour being more passive and letting the trend run, which in turn favours using relatively wide, volatility-adjusted stops - Keltner Channels are a very useful tool for this. For bullish trend days an initial stop can be placed either below the basis of the Keltner Channel which is a 20-period exponential moving average (EMA) or below lower Keltner Channel depending on how much room you want to give the trend. The 20-period EMA can also be used for trailing stops to lock in profits – for example a close below the 20-period EMA on the 5-min candle chart could trigger a trailing stop.

Profit Target: It is not uncommon for trend days to run right into the closing bell. It is also not uncommon for trend days to far exceed the daily ATR. These two factors make ‘exit on close’ or ‘exit on trailing stop’ a more optimum strategy than setting a fixed profit target.

Worked Example 1: S&P 500 Long

• Early Signs: Prior days range was very small. At the open we saw a clear directional bias with prices driving above the prior days high (PDH) and holding above VWAP.
  
• Entry: Simple momentum entry on a break to new highs for the day after a small pause.
  
• Stop Loss: Initial stop placed back below PDH and below 20 Period EMA.
  
• Target: Trail stops were not triggered – exit on close of day.
  

SPX 5min Candle Chart:

Past performance is not a reliable indicator of future results

Worked Example 2: Tesla short

• Early Signs: Prior day’s range was relatively small and directionless. There was significant directional bias from the open, the market broke below the prior day's low (PDL) and held below VWAP.
  
• Entry: Simple momentum entry on a break to new lows for the day.
  
• Stop Loss: Initial stop placed back above PDL and above 20 Period EMA.
  
• Target: Prices close above the 20EMA on the 5min candle chart triggered the trail stop. An exit on close would have delivered similar results.
  

TSLA 5min Candle Chart:

Past performance is not a reliable indicator of future results

Disclaimer: This is for information and learning purposes only. The information provided does not constitute investment advice nor take into account the individual financial circumstances or objectives of any investor. Any information that may be provided relating to past performance is not a reliable indicator of future results or performance.