What is a trend? The definition of a trend is a series of higher highs and higher lows for uptrends, and a series of lower highs and lower lows for downtrends. As I mentioned in last week's article, there are different types of trends. The primary trend which is influenced by the economic or business cycle can last for months or years. This trend is best observed on daily and weekly charts. The intermediate term trend is usually a profit taking move counter to the primary trend which can last for days or weeks. This trend is best observed on a 240 minute, or a 60 minute chart. The short term trends or intraday trends are more random reactions to news and economic data reports. Forex, futures, and equity traders all over the world attempt to trade these trends on one minute charts, tick charts, all the way up to 60 minute charts, in an attempt to profit from the volatility. Unless the news or economic report being released is totally unexpected, it will generally have a small affect on the primary or intermediate term trend. Bottom line, the larger the time frame, the more significant the trend, and short term traders in all asset classes need to be aware of the higher time frame trend in order to maximize their gains, and, more importantly, minimize their losses when trading during periods of high volatility.

Let's look at another way to describe a trend. This time, we will examine both high and low volatility movements that are responsible for the formation of a daily bar. Every trading day has a daily open, a high for the day, a low for the day, and a daily close. Some days have large ranges, and other days have narrow ranges. For a daily uptrend, the low must be higher than the previous day's low. Some days have similar highs and lows which indicate a sideways trading range on the daily chart. As the trading day progresses, price moves up and down in a seemingly random fashion. However, the explanation I have come to believe is that price moves up and down a ladder, or an order book of limit orders constantly filling orders to buy and sell that are resting at different prices. When I traded at a proprietary trading firm, I paid for the NYSE Specialist order book data feed which showed resting limit orders in the stocks that the Specialist made a market in. It was organized as a price ladder. When price is moving in a vertical manner, it is because there are very few orders to sell which will slow the buying momentum of price in an uptrend, or few buy orders to slow the selling momentum in a downtrend. Once price reaches a large pocket of either buy or sell orders, price begins to move in a horizontal manner to absorb the resting limit orders at this level. For example, the 5 minute chart of the EURUSD below shows price moving quickly higher from 1.4045 at around 2:00 AM Central time on Wednesday, 7-1-09, until reaching a small area of sell orders near 1.4080. The evidence that sell orders remain at this level is the strong move lower from the previous day's trading at the 1.4080 area representing the picture we call supply. Another pocket of supply at a higher price near the 1.4125 area is also noted on this chart. The reason given for the rally higher was the release of good German Retail Sales data from the Euro Zone at 1:00 AM Central time which is 6:00 GMT in Germany. The key in identifying these supply levels is looking for pivot highs as they represent the strongest levels, not periods of basing.

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The good economic data sparked a rally which stalled once price reached a level where the number of sell orders was large enough to shut off the buyers. The next chart shows that several attempts, (red arrows) and a few more hours were needed to finally absorb all the sell orders at the 1.4080 price level before the rally continued. As more economic data was released during the day at various times, price rose to higher pockets of sell orders, each time pausing to fill the orders before moving higher in search of more willing sellers. Once price reached the 1.4200 level, the amount of sell orders combined with profit taking ended the uptrend. On the daily chart, this candle will show up as a big green candle that closed about 60 pips off the highs of the day. A bullish day, but a warning to the candle stick trader that there are sellers near 1.4200. In the middle of the chart is the 7-1-09 daily candle overlaid on top of the 5 minute chart. The 6-30-09 daily candle is to the left, and the new 7-2-09 daily candle is seen forming from the Asian session into the London session. Notice how much of the previous day's uptrend the EURUSD has retraced at the time of this writing, and how several pockets of buy orders marked demand have been absorbed during this selloff. Below current price in this picture are a few small pockets of buy orders marked demand that will need to be absorbed if price is going to retrace 100% of the prior day's uptrend. The most important economic data release of the month, the June, 2009 US Non-Farm Payroll report is due to be released on July 2, 2009, one day early due to the Fourth of July holiday. This report has the potential to cause large moves depending on how the report is interpreted by the traders. A rather large number should cause a sharp rally in the EURUSD with all the offers above being filled or pulled, but a smaller than expected number may cause the bids below to be filled or pulled as the US Dollar rallies, and the Euro sells off. Until the report is released, price will continue to drift lower in search of buyers. As a side note, all the pockets of orders marked off on this 5 minute chart will not even be visible on a 60 minute chart. A swing trader or a position trader would not see or care about pockets of order from a small time frame chart, but active traders should. It is the foundation of the main strategy that we teach in the Extended Learning Track (XLT) program. Again, looking for pivot highs and lows tell us where the real sell and buy orders are.
Understanding the order flow going on behind the scenes is key and pivot highs and lows show us where that order flow is out of balance.

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