Developing workable strategies is key to identifying opportunities across financial markets. There are many different approaches that can be used when trading, with trend trading being one popular method.
Read on to find out exactly what trend trading is, how it works and the different types of trend trading strategies that could become part of your plan.
As suggested by the name, this involves trading trends and, like other methods of trading, using certain indicators to know when to enter or exit a market. But what exactly does it mean to trade trends?
Most people are familiar with the term 'trend' which is essentially the current direction or development of a particular concept. It can be applied to style, schools of thought, paradigms and even financial markets.
When trend trading, traders look to identify the market direction and aim to enter positions to make a profit on increases or decreases in price. While it can be said that this is the goal of each type of trading method, there are some key aspects of trend trading that are unique to this approach.
Technical analysis forms the backbone of this type of trading and there are a number of elements that can be used to develop a successful trend trading strategy.
In trading, there are three general trends in a market:
Strategies for this type of trading are focused on the use of technical indicators that can be analysed to spot opportunities in either uptrends or downtrends. When applying these strategies, it's wise to make sure that you fully understand the technical aspects involved to be able to trade successfully.
This strategy involves using an indicator that tracks the average price of a financial instrument or asset over a certain timeframe. This then creates one single line that can help to spot trends in the market.
Some commonly used moving averages in trend trading include the 50-day, 100-day and 200-day averages. It's also possible to track the moving average over shorter time frames such as hours or minutes.
While moving averages can't predict future trends, they can give a good indicator of the current trend. If, when plotted, the line is heading in the upwards direction, then the asset is said to be experiencing an uptrend; if the line points downwards, a trader can be fairly certain that it's in the middle of a downtrend.
Indicators can also be used to show crossovers - for example, when the moving average over 50 days drops or rises above 200 days. These can help to identify potential trend changes in market momentum.
The premise behind this strategy is as a momentum indicator which can identify overbought or oversold values of assets. Overbought refers to an asset that is currently trading at a value that's seen as being above its fair value, while oversold means that an asset is trading below its fair value.
These factors could be predictive of an upcoming price correction, signalling a price bounce or drop, although it's important to be aware that this is not always the case.
The scale of the index goes up to 100, with anything above 70 usually being a signal for an overbought security. Under 30 generally means that the asset is oversold.
Analysing the RSI can give a good indicator of changes in trends and enable traders to spot opportunities to enter and exit positions, depending on the market direction.
This trend trading strategy is used to find out how strong an upward or downward trend is. As with the RSI, the scale goes up to 100, with a higher number signalling a stronger trend.
The ADX is just one of three lines plotted when using this indicator, with the other two being the negative directional indicator and the positive directional indicator. While the ADX shows the strength, the other lines signal the market direction.
The trend is said to be strong when the ADX is above 25, whereas below 20 could mean a lack of trend.
Fairly complex calculations and formula are used within this type of technical analysis, making it a relatively accurate gauge for strength within a trend.
A pullback, or retracement, is when the price of an asset drops for a short period of time before the trend restarts again. Trend traders can take advantage of pullbacks to enter a position at a lower point (or higher point, depending on the market direction that's being traded) to maximise profits once the trend continues.
Moving average indicators, as described above, can be used to assess potential pullbacks but it's important to be sure that it is, in fact, a pullback and not a trend reversal.
This trend trading strategy does rely on trend reversals to be able to make a profit. By using the above indicators, as with pullback trading, it's possible to identify what could likely be a change in trend or movement direction of a market.
Profits can be gained from entering a position early enough, before the trend really takes hold. As is the case with every trend trading strategy, though, it's impossible to predict future markets to 100% accuracy so it's crucial to continually assess the risk/reward ratio.
Ultimately, this comes down to personal preference as well as technical and analytical skills. The right trend trading strategy for other traders might not necessarily be the one that suits you.
When considering what might be the best trend trading strategy for you, it's important to think about how much time you have available to dedicate to considering your approach as well as risk-management tools. A lack of research and planning can increase your chances of loss so it's vital to get up to speed with your trading strategy before implementing it. Most professionals will often use a combination of strategies when trend trading to give them the best opportunity of making a profit.
It's also a good idea to evaluate your trading style and approach as you become more familiar with it. This can highlight areas for improvement or identify where you might need to brush up on certain areas of market knowledge.
As with all approaches to trades, there are pros and cons of trend trading. While the ultimate goal is to make a profit, there are a number of advantages to using trend trading strategies:
There are also a number of cons of which to be aware when using any trend trading strategy:
While there are some similarities between trend trading and swing trading, the main difference is that trend trading is usually carried out over a longer time frame. Trading trends involves holding positions over a period of weeks, months or longer, while swing traders often place positions over just a few days.
Swing traders look to profit from short-term 'swings' or fluctuations in the market and therefore enter more positions than a trend trader, usually making smaller profits across each one.
As with trend trading, there are pros and cons to trading swings in the market so it's important to weigh up the benefits and risks of each before deciding which is the best method for your style of trading.
You can read more in our guide to swing trading.
Now that you understand all that there is to know about how to trade the trend, why not perfect your strategy with Tradu? You can execute trades across a range of markets, making it easy to choose the assets that suit you.
Take a look at our market guides to expand your knowledge:
Forex trading guide Stock trading guide Commodity trading guide Indices trading guide