Riding the Momentum: Al Brooks on Trading Strong Trends

For many traders, the most profitable periods are those characterized by strong, clear trends. These are the times when the market is moving decisively in one direction, offering the potential for substantial gains. Al Brooks, in his extensive work on price action, provides a detailed roadmap for identifying and trading these trends. He distinguishes between two primary types of trends—breakouts and channels—and offers specific strategies for each. Understanding this distinction is important for any trader looking to capitalize on market momentum.

A trend, in its simplest form, is a series of higher highs and higher lows (an uptrend) or lower highs and lower lows (a downtrend). But this simple definition belies the complex reality of the market. Trends can be strong or weak, orderly or chaotic. The first task of the price action trader is to correctly identify the nature of the trend they are dealing with. A breakout is a sudden, sharp move that pushes the price beyond a key support or resistance level. It is often accompanied by an increase in volume and volatility. A channel, on the other hand, is a more orderly trend that is contained within two parallel trendlines. The price oscillates between these two lines, creating a series of pullbacks and new highs (in an uptrend) or rallies and new lows (in a downtrend).

Trading a breakout requires a specific set of skills and a willingness to act decisively. The classic entry technique is to place a stop order one tick above the high of the breakout bar (in an uptrend) or one tick below the low of the breakout bar (in a downtrend). This ensures that the trader is only entering the market if the momentum of the breakout continues. The stop-loss is typically placed on the other side of the breakout bar, or at a logical support or resistance level. Profit targets in a breakout can be determined using the concept of a measured move. A measured move is a projection based on the height of the preceding trading range or consolidation pattern. For example, if the market breaks out of a 20-point trading range, the initial profit target would be 20 points above the breakout level. This is not a hard and fast rule, but it provides a logical framework for taking profits.

Trading a channel is a more nuanced affair. In a bull channel, the primary strategy is to buy pullbacks to the lower trendline or to a key moving average. In a bear channel, the strategy is to sell rallies to the upper trendline. The entry is often triggered by a reversal bar that forms at the trendline. For example, in a bull channel, a trader might wait for the price to pull back to the lower trendline and then form a strong bull reversal bar. The entry would be placed one tick above the high of that bar, with a stop-loss below the low of the bar. The profit target would be the upper trendline, or a new high in the trend. The key to trading channels is to be patient and to wait for the price to come to you. Chasing the market in a channel is a recipe for disaster, as the price is likely to reverse as it approaches the opposite trendline.

Risk management is paramount when trading trends. In a strong breakout, the risk is that the breakout will fail and the price will reverse sharply. This is why a tight stop-loss is essential. In a channel, the risk is that the channel will break and the trend will reverse. This is why it is important to take profits at the opposite trendline and to be prepared to exit the trade if the channel is violated. Al Brooks emphasizes that the trader must always be aware of the Trader's Equation, which is the balance between the probability of a trade being successful, the potential reward, and the potential risk. In a strong trend, the probability of a trade in the direction of the trend being successful is high. This means that the trader can accept a smaller reward-to-risk ratio. In a weaker trend or a trading range, the probability is lower, so the trader must insist on a higher reward-to-risk ratio.

Ultimately, the art of trading trends lies in the ability to correctly read the price action and to adapt to changing market conditions. A breakout can morph into a channel, and a channel can break down into a trading range. The price action trader must be constantly observing the market, looking for clues about its intentions. Is the trend accelerating or decelerating? Are the pullbacks becoming deeper or shallower? Are the trend bars getting stronger or weaker? By paying attention to these subtle cues, the trader can stay on the right side of the market and ride the wave of momentum for as long as it lasts.