Trend Trading Strategies

If you’re conservative in outlook, then trend trading, sometimes called trend following, may be your favourite spread betting strategy. It relies on the old trading adage, ‘Let the trend be your friend’.

Sometimes it is also compared to one of Newton’s laws of motion, the law that says that a body in motion tends to remain in motion unless acted upon by an external force. Similarly, trend trading quite simply expects that any existing trend will continue, and trades accordingly.

A quick glance at any trading chart will show you the evidence of this. About half the time you will find that prices are consistently either going up or down, also known as showing a trend.

Having decided that you want to follow a trend following strategy, you have to come up with two conditions – first, when will you decide that the trend is happening, with sufficient confidence that it’s worth you entering the bet; and second, when will you consider that the trend is over, and that you should exit the trade, preferably for a profit?

So first you need to identify a trend. Sometimes it will seem obvious, you simply have to look at the chart, but unless you can quantify exactly when you want to place the bet, you may not achieve consistent results in your trading.

The fact is that in any uptrend or downtrend there will always be pullbacks or retracements. Depending on the timescale that you use when drawing the chart, you may even see an uptrend on a weekly chart, and a downtrend on another scale.

But generally you will want to look at the chart for the type of trading you’re doing, for instance if you check your trades every night you will mainly look at a daily chart. The definition of an uptrend is that each successive peak is at a higher price, and each successive low point, on a retracement, is also at a higher price. Similarly for a downtrend, each successive low point is at a lower level, and each successive peak on a retracement is also at a lower level.

That formula allows you to look at the chart and confirm that by definition there is an uptrend or a downtrend. You can also use a longer term moving average to identify an overall trend, and even to facilitate your entry and exit points.

With this strategy, you can plot say a 50-period moving average on the chart. Anytime the price is above the moving average, and the average is heading up, this is your assurance that the trend is up. Should the price drop back and fall below the moving average, it is a sign that the uptrend has failed, and you should exit the trade.

You should experiment with the number of periods that you use for the moving average. The greater the number, the fewer but more certain your trades will be. With a short moving average, you will be chopping in and out of trades much more, and will lose more on spreads.

Assume you have placed your bet on the stock that is clearly trending, you need to protect yourself against a reversal in price that will take away your profit. If you’re not able to watch the markets all the time, you will find that the trailing stop is a useful tool that is offered by most if not all dealers.

The trailing stop is a movable stop order, which if the price touches it becomes a market order to sell. The level of the trailing stop order follows behind the price at a distance or price differential that you can set. In an uptrend, the trailing stop order never goes down but just ratchets up as the price increases.

Once the trend is over and the price starts to fall, the trailing stop is met and position is closed, with minimal loss. This happens automatically, whether or not you are looking at the markets, so it is a useful way to lock in your profits and avoid you riding the price back down to the starting point.

When you use the trailing stop, the only question is how far to set it below the price. You can set it at a fixed value, or some brokers allow a percentage setting. You need to review the price volatility to get an idea of the optimal value.

If you set it too close the price, you run the risk that you will be taken out of the trade on a pullback while there is still a good trend in place; but when you set it further away, you lose more before the trade is closed, if the trend has truly finished. A good rule of thumb is to set it about twice as far as you would expect the price to pull back, to avoid premature exiting.

In summary, trend following is a logical comfortable strategy that works for millions of traders. You simply have to set your entry and exit parameters using reasonable criteria.

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