- Trend trading, also known as trend following, is a trading strategy based on the assumption that the current trend is likely to continue and the stock will also move in the same direction.
- There are three types of trend: uptrend, downtrend and sideway.
- An uptrend is there when the prices make new highs. Conversely, prices make new lows when there is a downtrend.
What is trend trading?
Trend trading, also known as trend following, is a trading strategy based on the assumption that the current trend is likely to continue and the stock will also move in the same direction. Trend trading followers believe that trading markets always have an element of predictability. They also believe that analysis of the latest price fluctuations and historical data helps a trader to predict future price patterns. Trend trading followers seek to maximize the odds of gaining by taking positions along the course of predicted price movements.
In simple words, trend trading is all about purchasing or selling based on expected price movements or predicting trends in the market. Technical analysis and all of its components such as trendiness, chart patterns, indicators, and oscillators are very crucial for making trend trading possible. All these analysis tools help traders to predict the direction of the market and take position accordingly. Trend trading is a trading strategy that is practically a mid to long term strategy. However, it can theoretically cover any timeframe from short to long term.
Types of trends in the market
There are the following three types of trends in the market, uptrend, sideways, and downtrend.
- Uptrend involves a series of higher swing highs and higher swing lows.
- Sideways appears when the market price neither goes to lower price points nor the upper one.
- Downtrend involves a series of lower swing highs and lower swing lows.
Types of trends based on the strength of a trend
All serious traders must understand that knowing higher highs and lows of a trend is not enough as far as trend trading is concerned. Trends are not always equal in strength and it is better to know it for better trading. The following are the three types of trends according to the strength.
- A strong trend is there when buyers are in complete control with a very little or no selling pressure. A strong trend suggests shallow retracement. It is always best to trade on a breakout by entering on the lower timeframe. The pullback strategy doesn’t work in a strong trend because there is no retracement in the market.
- A healthy trend occurs when buyers are in control but the selling pressure is also present. A healthy trend suggests a decent retracement. It is reasonable to enter on a pullback when the trend is healthy.
- A weak trend is there when neither buyers nor sellers have control of the market but buyers have a slight advantage over the sellers. A weak trend means a steep retracement in the market. During a weak trend, it is ideal to enter the trade at support and resistance levels because the market here only tends to break highs only to retrace back to much lower levels.
How to identify a trend in the market?
Identifying a trend is not a difficult task but it is a bit tricky. Observation and analysis of the raw price action of an asset is the easiest way to identify a trend in the market. Technical trend traders always believe that candlesticks provide sufficient information regarding the price action to understand the market. According to the definition of the uptrend, an asset’s price making consistently higher highs and higher lows indicates an uptrend. Similarly, an asset’s price making consistent lower highs and lower lows shows a downtrend. However, the oscillation of prices between fixed levels of support and resistance indicates a sideways trend in the market. A trendline is very crucial as well to reveal the direction of the trend. A trendline imposed on the highs and lows of the price also reveals upper and lowers bounds of the trend.
How to trade with the trend?
The following are some of the key strategies to identify the entry points.
Moving average strategies help for trend trading
When a short term moving average crosses a longer moving average, it is prudent to enter a stock and exit the trade when the short-term moving average goes below the longer moving average. Another strategy is to enter a stock when the price of the stock goes above a particular moving average. Many expert trend traders also use a combination of different moving average strategies.
Support and resistance lines are also significant when planning to trade on the basis of trending. Potential entry points or placing stop-loss for bulls are areas of support while areas of resistance are potential entry points for bears.
Stock price chart patterns are also excellent tools to base your trading strategies. Chart patterns provide new buying and selling opportunities through recognizable chart patterns. However, only a few of the hundreds of chart patterns are reliable and have high accuracy rates.
Technical indicators are also exceptional tools to choose entry and exit points. There are various technical indicators that simplify price and volume data for the traders. When indicators suggest oversold market conditions, it is a buy signal. On the other hand, when the indicator suggests overbought market conditions, it is a selling signal.
Trend trading summary
Trend trading is a way of taking advantage of trends by following the trend in the market by assuming that trend is likely to continue in its direction. An uptrend is there when the prices make new highs. Conversely, prices make new lows when there is a downtrend. Traders also utilize other tools like chart patterns, trendlines, technical indicators, etc. to maximize the odds of gaining maximum profit from trend trading.