What Causes Trend Traders To Lose Money ?

Trend traders are one of the biggest groups of traders participating in the forex market. The trend itself is a concept which nearly all traders use in their trading strategy. What I want to spend some time looking at today, is the reason why trend traders overall lose money when trading the forex market.

First I’ll explain my definition of what a trend trader is, then I’ll show you where trend traders typically decide to enter their trades and then finally I’ll show you why they lose money with a simple example to better explain the points.

My Definition Of A Trend Trader

 

First I think it’s best if I give you my definition of a trend trader because what I call a trend trader and what other people call a trend traders are likely to be slightly different.

When most people say there a trend trader they mean they trade in the direction of the predominate trend in the market. The predominate trend is the direction the market has been moving in for the longest amount of time. My definition of a trend trader is similar to what I’ve said above but not quite the same, to me a trend trader is someone who uses a strategy to enter the market after the price has already moved.

The aim of the trend trader is to capture a continuation of a movement in the market as trend traders believe in the concept of trend which is ( if the price has moved in the same direction for a reasonable amount of time its likely to continue moving in the same direction in the future )

Therefore the trading strategy used by a trend trader will be geared towards exploiting this assumption made about the market. Trend traders wont be trying to predict when a reversal is going to occur because they believe once the price starts moving in one direction its got a better chance of moving in the same direction in the future.

Most people would call themselves trend traders even though they use a reversal strategy to enter into trading positions.

What these traders tend to do is get their trend direction from a higher time-frame and then trade in the direction of the higher time-frame trend on a lower time-frame. The people who trade like this are not what I call trend traders because although their trading in the direction of the trend they are not necessarily entering a trade simply based off the fact they have seen the price move in one direction for a long duration of time.

A trend trader to me is someone who upon seeing the price has been falling or rising for a long time enters a trade when the price is falling or rising, never when its moving against the trend.

One simple example of a strategy a trend trader would use is a moving average crossover.

Someone who uses a moving average to enter trading positions is a trend trader because the averages will only cross after the market has begun moving in one direction. In order for one average to cross the other the market has to have moved in one direction for a sufficient length of time otherwise the averages wont cross and the trader will not get into a trade.

 

What I Consider To Be A Trend

 

All traders have different ideas as to what constitutes to a trend in the market.

The majority believe the trend is the direction the market has been moving in for the longest duration of time on the time-frame they use to get the trend off. If the price off EUR/USD had been falling for 3 years on the daily chart then all the people who use the daily time-frame to determine what the trend is would say the market is in a downtrend.

My definition of the a trend is the same i.e the direction the market has been moving in for the longest stretch of time, the only difference is I know any movement can be considered a trend to a trader because of what up and down movements look like on different time-frames.

Here’s a quick example of what I mean….

image of downswing on daily chart of USD/JPY

I consider the down-swing marked above to be a trend even though overall the market itself is in a downtrend anyway.

The reason why is because of how the down-swing looks on the lower time-frames.

image of downswing on 15 minute chart

Here’s the same down-move only on a 15 minute chart instead of the daily chart.

To a trader who uses the 15 minute chart to determine what the current trend in the market is, the down-move above is classed by him as a downtrend regardless of what direction the market may have been moving in on the higher time-frames or which way it was moving previous to this down-swing taking place.

This length of time the market has been falling in this downswing is why a 15 minute trader would consider it to be a trend.

Each up-swing or down-swing you see in the market no matter how small it is, is a trend to the traders who use the time-frames which the up-swing or down-swing looks like it has been falling or rising on for a long time.

For example, the traders who use the daily chart will not have considered the down-swing above to be a trend because the market did not fall for what they would consider a long time. On the other hand the traders on the 15 minute chart see the down-swing as being a downtrend because on the 15 minute chart the down-swing is the direction the market has been moving in for the longest amount of time.

 

Why Do They Lose Money ?

 

It’s very simple why trend traders lose money…

They get into the trend too late, by the time their trading method has given them a signal to enter the trend the trend itself is about to come to an end, it may not be coming to an end completely but it will be getting ready to enter a consolidation or retracement.

In fact, the easiest way to know when tend traders have entered the market is by seeing a consolidation or retracement form.

When you see either one of these taking place on whatever time-frame your observing it means the trend traders are in the market and currently losing money.

To understand why you need to have knowledge on how orders enter the market.

image of downswing on usd/jpy

If the price of a currency is falling it means somebody has placed sell trades, in the image above the bank traders were placing sell trades back when the market was consolidating as evidenced by the large drop.

What causes the market direction to shift from going up to going down is the sell trades placed by the bank traders consuming all the buy orders from the retail traders, but what actually pushes the market lower is the retail trader who went long closing their trades at a loss.

Most of the movement marked in yellow box is from these long traders liquidating losing trades, not bank traders placing sell trades which what a lot of traders mistakenly assume.

When the large drop marked in yellow is over, the market has moved down enough for people to begin seeing the down-move as a new trend.

Traders begin placing sell trades under the impression the price is going to continue dropping in the future, what they don’t realize is their sell orders are going to be used by the bank traders to take profits off their own sell positions. Eventually the price drops to a point where enough trend traders have placed sell trades that the banks can now start taking profits off their own trades.

This point can be seen in the image as a retracement.

The reason we see the retracement appear at this location as opposed to appearing right after the drop, is because at the end of the large drop there were not enough sell orders in the market for the banks to use to take profits off their trades. They need people to be selling in order to take profits, the more profits they wish to take the more people they need to be selling.

As you can see the retracement causes the price to move up, the move up is what causes the trend traders to lose money.

The majority of trend traders have placed their trades right before the retracement occurred, when the price suddenly moves higher their sell trades which may have been in a small amount turn negative and their unwillingly put in a situation where they will need to close their trades if the price increases enough as the loss on their sell trades will get bigger the further up the price moves.

image of downtrend on eur/usd

Here’s another example of trend traders entering late into the market.

On the image of the EUR/USD downtrend above you can see how a much bigger retracement and consolidation took place after the market had been moving lower.

All the pauses seen before this had been small and only lasted a few days. But there comes a point when a small retracement takes place which I’ve marked with an arrow in the image. This retracement tells us the banks have taken some profits off their sell trades.

Whilst they had been doing this previous to the retracement as evidenced by the little pauses I’ve marked with the blue lines, the fact that the retracement was much bigger than the pauses coupled with the fact the price actually manged to move higher during the retracement which it didn’t do on any of the pauses, tells us the trend traders must have entered the market and have started to see a trend actually taking place.

If they haven’t entered the market then there would be no way for the banks to take profits off their sell trades and we wouldn’t see a retracement take place followed by a multi-week consolidation.

The banks need other traders to be selling in order to take profits off their trades, the bigger the profit they want to take, the higher the number of traders they need to be selling. By the time the market has moved down this far the banks trades are in massive amount of profit, if they want to secure a large amount of that profit they need an equally big amount of sell orders coming into the market.

These sell orders come from the trend traders finally coming to a conclusion the market is in a downtrend due to the length of time the price has been moving lower.

As soon as they believe a trend exists in the market they’ll jump into their trades en mass and the price will start to fall, it will be at this point when the banks start taking a much bigger amount of profits off their trades. You’ll see this in the market in the form of a consolidation or retracement which is noticeably larger than any consolidation or retracement seen previously in the trend.

After the bigger retracement or consolidation has ended and the price is moving back in the direction of the trend, trend traders will be entering the market after any significant move in the direction of the trend has taken place. Again you’ll see this on the charts as a consolidation or retracement.

 

Summary

Trend traders don’t lose money because their bad at trading, they lose it because they fail to spot a trend too late. Their lateness in entering a trade causes them to get in the market right at the wrong time and unwillingly give the bank traders the opportunity to take profits off their trades.

If some trend traders were able to shorten the amount of time it took for them to see a trend in the market the majority of them would probably be making a lot of money as they will be entering their trades at a point where the other trend traders will not have identified the existence of a trend, so the profit taking by the banks will not have come into the market yet, meaning the trend traders trades are safe and unlikely to lose them money.

Thanks for reading, please leave any questions in the comment section below.

 

 

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