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’.

What is Trend Following?

The “trend following” style of trading is a largely mechanical trading style predicated on the ideas that:

a) Every trader needs a favourable price trend, however short, in order to make money.

b) You can’t predict the onset of a trend, so it’s better to follow it once it’s started.

c) You can’t predict how long a trend will last, so you need to hold on for as long as possible… but no longer.

My own approach to trading has a significant trend following component consistent with points a) and c), but I am personally rather more skeptical of waiting until a trend has firmly established itself before deciding to “follow” it. Nonetheless, trend following purists argue that you don’t need to catch the exact turning points at all, providing you capture the major part of the price move.

Trend Trading: A Proven Strategy for Success

Trend trading is one of the most intuitive and widely used strategies in financial markets. It’s often compared to Newton’s first law of motion: a body in motion stays in motion unless acted upon by an external force. Similarly, trend trading assumes that an existing trend is likely to continue, allowing traders to capitalize on consistent market movements. In this article, we’ll explore the essentials of trend trading, including identifying trends, setting entry and exit points, managing risks, and making the most of this popular approach.

Understanding Trend Trading

At its core, trend trading involves identifying the direction of market prices — upward (uptrend) or downward (downtrend) — and making trades aligned with these movements. A glance at any trading chart reveals that markets often exhibit trends around 50% of the time, providing ample opportunities for traders to profit.

How to Identify a Trend

To trade trends effectively, you need a clear method for identifying when a trend starts and ends. Here are some approaches:

1. Visual Inspection

• On a daily chart:
  • Uptrend: Successive higher highs and higher lows.
  • Downtrend: Successive lower highs and lower lows.
• Example: If each retracement in an uptrend forms a higher low, it confirms the continuation of the trend.

2. Moving Averages

• Use a long-term moving average (e.g., 50-period) to identify trends.
• When prices are consistently above a rising moving average, the trend is up.
• Conversely, if prices fall below a declining moving average, the trend is down.

When to Enter a Trade

Once you’ve identified a trend, you need to decide the optimal entry point. Here are two common strategies:

1. Early Entry
   • Enter just before the trend starts by analyzing breakouts or other leading indicators.
   • Pros: Potential for maximum profits.
   • Cons: Higher risk of false signals.
2. Confirmed Entry
   • Wait until the trend is well-established, confirmed by higher highs or lower lows.
   • Pros: Reduced risk of false signals.
   • Cons: May miss early profits.

When to Exit a Trade

Exiting at the right time is critical to locking in profits and limiting losses.

1. Using Moving Averages

• Exit when the price crosses below a rising moving average in an uptrend or above a falling average in a downtrend.

2. Trailing Stops

• A trailing stop automatically adjusts as the price moves in your favor, locking in profits while protecting against reversals.
• Example: Set the trailing stop at twice the average pullback distance to avoid premature exits.

3. Volatility-Based Exits

• Analyze historical price volatility to set an optimal trailing stop distance or fixed-point exit.

Risk Management in Trend Trading

Effective risk management is crucial to long-term success. Here’s how to protect yourself:

• Avoid Premature Exits: Set trailing stops far enough to account for normal pullbacks.
• Use Stop-Loss Orders: Establish a predefined level to cut losses if the trend reverses.
• Position Sizing: Trade with a size that aligns with your risk tolerance and account size.

Challenges of Trend Trading

Trend trading isn’t without its hurdles:

1. Late Recognition: Trends are often easiest to spot when they’re already well-developed, leaving limited profit potential.
2. Whipsaw Losses: False breakouts and trend reversals can lead to losses before a trend solidifies.

Tips for Trend Trading Success

1. Be Patient: Trends take time to develop, so don’t rush entries or exits.
2. Follow the Rules: Define clear criteria for identifying trends and stick to them.
3. Run Your Profits: Hold onto winning trades as long as the trend remains intact.
4. Learn from Losses: Whipsaw losses are part of trend trading; use them to refine your strategy.

The Trend is Your Friend (Until It Ends)

Trend trading is a logical and rewarding strategy for traders who are disciplined and patient. By focusing on identifying trends, setting clear entry and exit criteria, and managing risks effectively, you can take advantage of market momentum and improve your trading success. Remember, the key to success lies in holding onto profitable trades and letting the trend work in your favor.

Embrace the trend, because in trading, the trend truly is your friend!