Trend Trading

Updated on April 25, 2024
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Trend Trading?

Trend trading is a distinct strategy that identifies and utilizes market momentum to earn profit. Its application is found in various markets, including stocks, bonds, currencies, metals, and commodities. To assess market momentum, investors employ a variety of technical indicators.

What Is Trend Trading

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The technique is based on joining the trend and then quitting it before reaching a stoppage. However, because of the trend’s dynamic character, traders have difficulty predicting where it will go and how long it will stay at a particular position. As a result, it is critical to have insight, prudence, and flexibility when riding the trend.

Key Takeaways

  • Trend trading system entails using technical analysis to determine the right market momentum for profitable investments.
  • Trend traders do not rely solely on future forecasts or other financial research reports; instead, they join the present trend and leave when it is set to reverse.
  • Staying cautious and deciding on a prompt timeframe to ride the trend and entry and exit points will make the trend-following strategy effective.
  • The leading indicators include the moving average, relative strength index (RSI), and average directional index (ADX).

Trend Trading Explained

Trend trading is based on the concept that the price of an asset moves in a specific direction but not in a straight path with a degree of predictability for a particular period. Based on the identified trend, traders can devise short-, mid-, or long-term strategies. They use technical indicatorsTechnical IndicatorsTechnical indicators refer to technical analysis tools used by investors to make investment decisions based on future price movements derived primarily from historical prices. read more with market data to understand the momentum trend trading and determine whether an uptrend or a downtrend is happening.

momentum trend trading

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Even if there are swings, an uptrend means prices are moving up, while downtrends indicate that prices are sinking. Usually, uptrends are manifested by a series of high “swing highs” and high “swing lows” moving up, making a climbing trajectory. Conversely, downtrends usually contain low “swing highs” and low “swing lows,” making a path that is heading downward. In both cases smoothing out the deviations indicates a clear uptrend and downtrend scenario, respectively.

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Strategies

There are various levels of strategies ranging from short-term to long-term in a trend trading system. It’s a combination of data and technology that will identify trends and help with risk management. Identifying trends correctly is the heart of any strategy. For instance, it is vital to consider the amplitude of swings when deciding on trading entry and exit positions for trend trading stocks.

Trend traders use several indicators to get trend signals and benefit from different methodologies. For instance, day traders benefit from short-term price movements, whereas position tradersPosition TradersPosition trading is a strategy in which a trading position is held for a long period in order to achieve a profit goal. In position trading, a trader will typically think long-term, and the position will be held for a long time, regardless of short-term fluctuations.read more benefit from holding on to a position for an extended period. The long positionLong PositionLong position denotes buying of a stock, currency or commodity in the hope that the future price will get higher from the present price. The security can be bought in the cash market or in the derivative market. The course of action suggests that the investor or the trader is expecting an upward movement of the stock from is prevailing levels.read more approach depends on price movement achieving higher peaks and a short positionShort PositionA short position is a practice where the investors sell stocks that they don't own at the time of selling; the investors do so by borrowing the shares from some other investors to promise that the former will return the stocks to the latter on a later date.read more in case of day trend trading happens if price action indicates lower lows. They would quit the transaction if analytics suggested that a reversal was likely.

Advanced traders use leverage while they adopt trend-following strategies. Investors borrow the required amount to increase the trading value beyond what they currently have and play with tight-stop or profit-taking techniques to earn effectively. Such methods are vital to traders to ensure that they won’t lose money if there’s a quick trade reversal.

Indicators

Technical Traders need reliable indicators to identify trade signalsTrade SignalsA trade signal is an analytical tool that provides a trader the cue to make buy or sell orders to maximize profits. Various forms of trade signals exist, with differing goals and potential profits. Traders have been using technical indicators to reduce their risk in trading for a long time.read more and create strategies. Most traders use more than one indicator to achieve higher accuracy.

#1 – Moving Average

The moving averageMoving AverageMoving Average (MA), commonly used in capital markets, can be defined as a succession of mean that is derived from a successive period of numbers or values and the same would be calculated continually as the new data is available. This can be lagging or trend-following indicator as this would be based on previous numbers.read more is one of the fundamental indicators used in trend analysis. It determines the average price of an asset during a specific timeframe by examining the recent prices and smoothing out the fluctuations. Most popular options include 50, 100, and 200-day moving averages. The moving average does not predict prices. It moves much slower than the actual market, but it can be helpful for traders as they will confirm whether an asset is moving up in price. Prices above the moving average mean that the overall trend is up.

#2 – Relative Strength Index (RSI)

RSI represents momentum trend trading in the market and helps identify when an asset is either overbought or oversold. Hence it guides investors in deciding on exit and entry points. The relative strength value moves between 0 and 100. If the line is over 70, the asset is overbought. If it’s below 30, it’s oversold or undervalued, which may be the perfect time to buy it.

Let us look at this Bitcoin/US Dollar chart to understand the concept better.

Bitcoin US Dollar chart

Source

The white line in the chart represents the relative strength index. On December 17, 2019, the value dropped below 30, indicating oversold conditions. That said, on February 9, 2020, the value jumped above 70, signaling overbought conditions. The purple rectangle in the chart demonstrates the relative strength index range that goes from 30 to 70.

#3 – Average Directional Index (ADX)

ADX analyzes the intensity of a trend. ADX line moves between 0 to 100. If a trend is strong, the ADX value lies between 25 and 100, and a value below 25 means the movement is weak.

Let us look at this Brent chart to better understand how ADX works.

Brent chart

Source

As one can observe in the above chart, the red line below the candlesticks represents the ADX line. At 1 pm on September 12, 2023, the ADX value is 14.05, indicating that the price movement is weak. That said, on October 5, 2023, at 9 pm, the ADX value was 93.87, indicating a very strong trend.

To look at more such charts and improve their knowledge concerning the relative strength index, average directional index, and other technical analysis indicators, individuals can go to the TradingView platform.  

Example

Let us look at some examples to understand the concept.

Example #1

Let’s look into Nike stock price movement for a timeframe from September 2020 to February 2021 to understand the movement of trend trading stocks.

Nike stock price movement for timeframe

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The price moves upward during the specified period even if it swings highs and swings lows. There’s a clear uptrend in these six months. First, there’s a small impulse from August to late September. Then, a much stronger one from November to the middle of January. Various indicators provide more accurate information, whether a strong trend or situation encompasses overbought or oversold scenarios.

Example #2

The S&P500 trendline is set to break the bear market trend. It is seen that in spite of the market downturn due to a fall in US retail sales, again it is on the rise. The confidence is due to the strong labor market. But if is it depending a lot on the US labor market, then this is definitely risky. The trend shows the price climbed and then fell. But again the resistance level turned into support.

S&P500 trendline analysis

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Trend Trading In Forex

Trend strategy in Forex is a common phenomenon. A Forex trading course helps traders understand using technical analysisTechnical AnalysisTechnical analysis is the process of predicting the price movement of tradable instruments using historical trading charts and market data.read more to identify the direction of price movement, which may be a day trend trading, or weekly, or monthly, etc. Technical traders use forex trendline trading strategies to analyze important features like trend patterns or support and resistance levels. We can say that if a forex pair exhibits a downward trend, it is appropriate to sell, and it is a buy case if the forex pair shows an upward trend. However, this market has its specificities, too. Analyzing the geopolitical and economic trends of the countries involved is an excellent way to make better investments.

Trend Trading Vs Swing Trading

Trend trading refers to using long-term trends in price movement to earn profit in the stock market, whereas swing trading uses short-term price movements to earn profit. But the basic differences between them are as follows:

Trend tradingSwing Trading
It considers a longer timeframe.It considers a very short timeframe, usually one or two days.
Traders take smaller positions.Traders take larger positions.
Traders wait for good and strong price movements.Traders look for small and sudden changes.
It usually generates higher returns.It generates smaller returns due to a shorter time period.
  

Frequently Asked Questions (FAQs)

Does trend trading work?

Yes, many traders use the trend-following strategy. Identifying a trend at its starting phase, optimal buying point, riding it, finding optimal selling point, and prompt liquidation of the position helps make a profit or reduce the loss of money.

What is a trend trading strategy?

Trend following is a strategy that involves traders analyzing and locating a trend and its momentum- followed by riding on the trend extracting the profit with prompt entry and exit decisions. Generally, when an asset demonstrates an upward trend, traders often look to enter into an extended position and buy. However, in the opposite scenario, traders would go short and sell when the trend direction is downward.

What is swing trading vs. trend trading?

Trend traders are concerned with an uptrend or downtrend scenario, whereas swing traders are into range-bound markets, with trading actions based on support and resistance levels. Furthermore, swing traders focus on short-term price changes than trend followers, who also have a long-term outlook.

This has been a guide to what is Trend Trading. Here we explain the strategies, and how it works in FOREX along with indicators, and vs swing trading. You may learn more about financing from the following articles –