Trend Is Your Friend: Everything You Need To Know About This Strategy
When the price of a security is moving in a single direction, such as up or down, it is called a trend. Watching trends is a trading style that attempts to gather gains through the analysis of the security’s momentum in a specific direction.
When a security is trading upward, traders enter into a long position, which means they expect the price to rise in the future and benefit from the increased prices. An uptrend is defined by higher-swing highs and higher-swing lows.
Traders opt for entering a short position when the asset is trending lower. A downtrend is characterized by lower-swing highs and lower-swing lows. That is why the trend is your friend.
Understanding Trend Trading
Trend trading assumes that a stock will continue to move just like it is ‘trending’ currently. Such strategies often consist of stop-loss or take-profit provisions in order to avoid big losses or lock in a profit if a trend reversal takes place. Trend trading is used by long, intermediate, and short-term traders.
Traders use price action as well as other technical tools to understand the trend direction and the timeframe in which it may be shifting.
Price action traders analyse the price movements on a chart. The traders, for an uptrend, want to see the prices moving above recent highs and, when the value drops, remain above prior swing lows. This signifies that even though the value is oscillating up and down, the overall trajectory is up.
The same concept is applicable to downtrends, with traders looking to see the prices make overall lower highs and lower lows. When that is not happening any longer, the downtrend is over or in question, and thus the trend trader will no longer want to hold a short position.
Trend Trading Strategies
There are several different trend trading strategies and each of them use a variety of price action methods and indicators. For all strategies, the risk can be managed by using a stop loss.
For an uptrend, a stop loss is kept below a swing low that took place prior to entry or below another support level. For a short position and a downtrend, a stop loss is usually placed just above the resistance level or above a prior swing. Trend is your friend because this is so easy.
Moving Averages
Moving averages smooth price data by forming a single flowing line, which represents the average price over a span of time. The selection of moving average depends on the time frame in which a trader trades.
These strategies include getting into a long position when a short-term moving average goes over a longer-term moving average or getting into a short position when a short-term moving average goes below a longer-term moving average.
Alternatively, many traders may look for when the price moves above a moving average to indicate a long position, or when the value crosses below the average to signify a short position.
Usually, moving average strategies are merged with some other types of technical analysis to identify the signals. This may involve looking at price action to ascertain the trend, since moving average offers very poor signals in the absence of any trend; the value just whips back and forth across the moving average.
Moving averages are also utilised for analysis. When the price of a security is above the moving average, it aids the appearance of an uptrend. Similarly, the presence of a downtrend is indicated it the price is below the moving average.
Momentum Indicators
There are several momentum indicators and strategies. For instance, looking for an uptrend and using relative strength index (RSI) to indicate exits and entries.
A trader may wait for the relative strength index to drop below 30 and then climb above it. This could indicate a long position as long as the overall uptrend stays intact. The indicator is signaling that the price of the security pulled back but is now beginning to rise again in-line with the overall uptrend.
The trader could possibly exit when RSI climbs above 70 and 80 and then drops back below the selected level.
Trendlines & Chart Patterns
A trendline is a line made along with swing lows in an uptrend or swing highs in a downtrend. It shows a potential area where the price of a security may pull back to in the future.
A few traders choose to purchase during an uptrend as the price pulls back to and then jumps higher off of, a climbing trendline. Similarly, traders choose to short during a trend as the value rises to and then drops from a declining trendline.
Trend traders will also look for chart patterns like triangles or flags, which signify a possible continuation of a trend. For instance, in case the price is climbing aggressively and then forms a triangle of a flag, a trend trader will look for the value to break out of the pattern to indicate a continuation of the uptrend.
Why Is The Trend Is Your Friend Strategy Effective?
Trend trading is a long-standing and common approach to trading because it works. The following are the reasons why a trend is your friend strategy works.
The “Whales” Control The Market
The markets are priced-based on the auction model of bids and ask sellers and buyers, so logically the market participants with enormous capital or big whales, such as pension plans, hedge funds, mutual funds, banks, insurance companies, and other such institutions, make the big moves in the market.
This does not mean that they are doing something illegal; large amounts of capital invested in the markets cause them to shift. And, because you are following the leaders, trend trading is the most reliable and easiest way to make money.
Trends Trading Is Amongst The Simplest Approaches To Trading
The world of trading is becoming increasingly complex, causing various traders to be victims of information overload. Due to the infinite number of trading systems, automated computer programs, indicators, and trading theories coming up every day, new traders can feel confused.
This is why trend is your friend. It is a simple approach to the market as it does not need various fancy technologies or deep-rooted knowledge of mathematics, market theory or Geometry.
Trend Trading Has Passed The Test Of Time
Documentation of trend trading dates back to the 19th and 20th centuries and still continues to be popular today. Not only it is mostly accurate, but also enables beginners to understand the market while earning money.
The Bottom Line
Trend refers to the general direction of an asset’s price. It is extremely easy to locate a trend and benefit from it. That is why traders usually say that trend is your friend.
Through trend trade, you can enter the market as soon as you spot an uptrend, only to sell your stocks at high prices. Similarly, you can exit the market if you locate a downtrend and save yourself from losing money.
By using the above-mentioned strategies along with other strategies, a trader may benefit massively. However, it is not certain how long the trend will continue. Therefore, entering and exiting the market at the right time is crucial.