Trend trading is a trend trading strategy where trend traders seek to capitalize on the direction of trends in financial markets. Whether it’s upward trends or downward trends, the goal is to enter trades in alignment with the market direction and ride the trend strength for maximum gains. This approach is used by swing traders, position traders, and day traders across different time frames, from the daily chart to the weekly chart.
What Is A Trend?
A trend is simply a sustained price movement in one direction. This may occur in any financial instrument. Trends occur in stock markets, commodity markets, futures, and forex markets. They occur in all time frames; however, the longer the time frame, the larger and more rewarding trends can be.
The nature and magnitude of trends vary by asset class. However, trend-following strategies can be used in stocks, futures, and forex markets.
Components Of Trend Trading Strategies:
The great thing about this trading strategy is that similar (or even identical) common trend trading strategies can work across a range of markets. For example, one of our trend-following strategies works exceptionally well on stock charts but also works on futures and forex with no modifications at all. This is because most markets trend, and the trading strategy is very robust. All it requires is:
- A way to identify when a trend direction is in place
- A low-risk entry point
- An initial stop loss to get you out if you are wrong
- An exit rule that gets you out when the trend reversal occurs
If your trend trading strategy has all these components, combined with good risk management strategy, you are on your way to a profitable trend-following strategy! (Of course, you will need to undertake the correct trading plan development for yourself to ensure profitability, as there are no guarantees.)
Trend Following Stocks:
Stock trends occur because of changing fundamental conditions for the stock and also because of overall market momentum. Both long-term trends and short-term trends in stocks are tradable, although long-term trends can be substantially more profitable than short-term trends.
By far, the best trends in the stock markets occur when a company is growing rapidly and the broader market sentiment is increasingly positive. However, strong trends can occur at any time. With a total universe of thousands of stocks globally, there are always some good trends underway – your job is to implement a trading system that will find them!
Following trend indicators, such as moving averages or momentum indicators, helps identify successful trades. By tracking price levels and price charts, trend traders can pinpoint trend confirmation and take advantage of profitable trades.
Trend Following Stocks Example: Incitec (IPL:ASX)
Trend Following Stocks Example: Cochlear (COH:ASX)
Trend Following Stocks Example: Jb Hifi (JBH:ASX)
You can see why trend following stocks can be so profitable – you only need a couple of these great moves each year to offset your numerous small losses and you can earn substantial returns. With good risk control and diversification this strategy can perform very well indeed.
In our trading systems section you will see that these trends can be identified and exploited using simple mechanical trading systems which look only at price data – it is not necessary to do hundreds of hours of fundamental research to identify a stock that is trending and profit from it.
The reasons trend following stocks works are covered in more detail here.
Futures Trend Trading:
Trend trading in the futures market can also be extremely profitable. Similar to stocks you will find that long side trends are larger and more profitable than short side trends, but both are tradable.
The important distinction for trend following in futures and commodities is that because futures contracts expire, the trader may have to intermittently roll over to the next contract month to stay with the trend.
These contract rolls add a slight degree of complexity relative to stocks, but this is well worth it given the additional diversification and returns that are available through trend following in futures.
Just as in stocks, futures trend following can be undertaken on a purely mechanical basis using only price data.
Trends in futures markets may not be as dramatic as the stock trends you saw above, but there are many examples of great trends in the futures markets. A trend in gold is illustrated below using continuous contract price data.
Futures Trend Trading Example: Gold
There are a limited number of tradable futures markets globally (<100 depending on your definition of tradable). This means there are typically fewer trends at any one time in the futures market compared to stocks, so it becomes important to catch every major trend that occurs when trading futures or commodities.
If you miss a trend in the futures market, that may just have been the big one that would have made your entire year’s profitability…whereas if you miss a trend in the stock market, there will likely be many more trends for you to catch. This has some implications for how you structure your entry trigger for futures trades compared to stock trades.
Despite this drawback, trend following in the futures markets is extremely powerful because there can be much more diversification between futures instruments than there is between stocks. This diversification can give a futures trend following system higher risk adjusted returns than a stock system because stocks tend to be so highly correlated to each other.
Forex Trend Trading:
A forex trend occurs when one currency strengthens in comparison to another. For example, if the Australian dollar is strengthening due to rising interest rates and the US dollar is weakening due to falling rates, then the AUD/USD exchange rate would likely exhibit a strong trend.
Just as in stock markets and futures markets, forex trend-following strategies can be based solely on price movements and perform well over time. Technical traders often use exponential moving averages, momentum indicators, and trend lines to track and confirm trends.
Forex Trend Trading Example: AUDUSD
How Does Trend Trading Work?
Trend trading is simply an approach in which you identify that a trend is in place, enter the market in the direction of the trend and hold the position until the trend reverses.
After entering at a low risk entry point, trend following generally uses an initial stop loss point which is fairly close to the entry point. Once a trade is profitable a wide trailing stop allows plenty of price movement before exiting a trade. This ensures you remain in the trade for the duration of the trend and don’t exit too early.
The wide trailing stops work because trends can get volatile and may move against you quite a way before rocketing off in the desired direction again. If you use too tight a trailing stop then you will be forced out of the trend and miss out on the potential profit from the big move later in the trend.
When your trend following system is right (around 30% of the time) and the trend continues, large profits are made on the trade. When the system is wrong (around 70% of the time) you exit quickly at a small loss and move on to the next trade.
Trend following systems make money overall, even with this low percentage of winning trades, because winning trades are much larger than losing trades.
Trend Trading and Risk Management
When buying trending instruments, there is a high probability that your position could reverse and hit it’s stop loss before turning into a major trend. So the win rate of a typical trend following system is between 30-50%. This means you need to be willing and able to tolerate a large number of losses when following a trend trading system.
The large number of losses combined with the long duration of major trends and the fluctuations you must tolerate as you wait patiently for your trend to grow make it extremely important to incorporate risk management in your trading strategy.
For trend trading systems risk management is about keeping your risk on each trade small so you can tolerate a long string of losses without a large drawdown.
Your positions must also be small so you can hold a highly diversified portfolio of instruments. With greater diversification there is a better chance you will catch a large trend in one of your positions. The flipside of this is if you diversify too broadly your positions will be so small that when you do catch a large trend you will not make much money.
Backtesting your trend following system and optimizing the risk per trade and the maximum exposure on each trade will help you find the sweet spot for your position size. The table below illustrates the tradeoff that risk management balances with trend following trading systems:
Trend trading has a lower initial trade risk profile than mean reversion trading systems because you are entering in the direction of a trend which is in place when you execute the trade. Mean reversion trading systems try to anticipate a change in the direction of the trend so they are often subject to “catching a falling knife” which means the positions can move a long way against you before they recover… this is usually not the case in trend following where losses can be kept small compared to the size of winning trades.
In a trend following trading system, you have clear-cut answers for questions like when to get out of a losing position or when to reap the rewards of a winning position. Remember that one of the components of trend trading is identifying your position size upon entry, which means you have a specific rule about how much you can buy or sell depending on how much money you have.
Trend trading requires that you stick to these rules without letting any wild guesses or gut feel get in the way of your decision.
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Leverage and Margins in Trend Trading
As with other kinds of trading, trend trading is possible using leverage. Through leverage, you can trade shares, forex lots, or contracts by combining a small portion of your own money with a more substantial sum of borrowed money.
Leverage allows you to trade even when your capital isn’t enough, which is why it’s expressed in ratios to represent the money you can trade based on the actual money you have. Say, you choose 100:1 leverage, it means you can increase the size of your trade up to 100 times. So, if you have approximately $1,000 in your trading account, you can trade as much as $100,000.
Of course, you’ll need a minimum amount of cash to be allowed to trade—this is called margin. The margin is usually expressed in percentage to indicate how much your brokerage firm requires from you to open or maintain a position in the trading market.
Based on the example above, you can trade on a $100,000 contract as long as you meet the 1% margin requirement of your broker. Thus the margin can help you determine the maximum leverage you can get in a particular trade.
When used properly, leverage can result in more trading activity than what you can afford if you were trading with cash alone. Unfortunately leverage is a double edged sword. It can increase your exposure and allow you to grow profits more quickly, but when you are leveraged and the markets move against you your losses mount up extremely quickly.
It’s always advisable to choose the right leverage level, which can be summed up in these rules:
- Maintain low leverage levels, which can range from 1:1 to 1:4 in stock trading, and from 5:1 to 10:1 in forex and futures trading. Your broker may give you more, but that does not make it a good idea – the risk of blowing up your account increases exponentially as leverage increases
- Use trailing stops as a way to lock in profits and to set a cap on potential downfall
- Limit the risk per trade to between 0.5% and 1% of your trading account depending on the system. The level of risk should be backtested to understand the drawdown potential and ensure you are comfortable with the level of risk assumed.
Trend Trading Can Be Emotionally Challenging:
The psychological difficulty most people have is that trend following requires you to be wrong most of the time. This can be emotionally challenging because most people have the subconscious desire to be right (this comes from our school education system which was not designed to produce outstanding traders!!!)
Trend following is practically very simple but can be emotionally challenging.
New traders looking for reassurance that they are doing well expect reassurance to come in the form of winning trades – these may be infrequent with this trading strategy. However, total profitability is what we should really be interested in, not just being right.
Can A Trend Trading Strategy Fit In With A Day Job?
YES! Trend following is a form of trading that can be learned and can fit in easily with whatever else you have in your life at the moment.
Trend trading systems require very little time each day to execute and can be run while you still have a full time job.
Once you understand the concepts and codify them into a mechanical trading system it becomes a matter of simply running your system scans each day and executing to the rules.
Trend following strategies should not involve any judgment, so assuming everything is documented properly in your trading plan the decisions are very quick to make on a day to day basis. Our major stock system takes about 30 minutes a day to execute.
What Are The Components Of A Trend Trading Strategy?
Trend following strategies are simple systems with mechanical trading rules that identify when a trend is in place. The system gets you in to ride the trend as long as it remains in place. They are applied to a broad range of securities or instruments and so need to be simple and robust to work effectively.
The standard components of a trading following strategy include:
- Setup
- Entry Trigger
- Initial stop loss
- Exit rules
- Money management and position size rules
The correct approach to each of these trading system components for a good trend trading system is described in our trading systems section.
Trend following strategies typically do not employ profit targets or time based exits because profits come from letting trades run and develop for as long as possible within your chosen timeframe. Profit targets and time based exits are more commonly used in swing trading and mean reversion systems.
Trend Trading Indicators
Trend traders use technical indicators to analyze the strength of a market trend and how likely that trend will continue. You should use one or more of these trend trading indicators as signals to help you determine the best time to enter and exit trend trading positions.
- Moving Averages
Moving averages are one of the most commonly used trend trading indicators. They make it easier to see the predominant market trend by smoothing out price data in a chart in a single flowing line, so that you can distinguish between actual trend direction versus mere market “noise.” This indicator takes the average closing price over a set period of time.
A moving average may be simple or exponential. Unlike the latter, the former doesn’t take spikes into account so you may see a smoother moving average line but the picture it forms is less detailed, preventing you from reacting to price movements quickly.
Moving averages are used as trend filters to ensure that a stock or instrument is actually trending before getting into the trade. For example when the price is above the 50 bar moving average and the 50 bar moving average is above the 200 bar moving average, there is little doubt that the trend is up as illustrated in the chart below:
- Breakouts
A breakout is when a price movement goes beyond a certain trading range. When we talk about breakouts, there are three main types:
- Support / Resistance Breakouts
- Donchian Channel Breakouts
- Volatility Breakouts
Support / Resistance breakouts are the most widely discussed of the three breakout types A breakout through resistance is when the price of a stock / commodity / asset is rising and it approaches a resistance level. If the resistance level holds and the price retraces from the resistance, there is no breakout, but if the price pushes through the resistance level then the price is “Breaking Out” of the resistance level.
Conversely, a support breakout is when the price of an asset or commodity is falling and there is a level of support that tends to stop the decline. When the price moves down through the support level it is “Breaking Out” below the support level.
Support / Resistance breakouts are actually the least useful for systematic trading because they are subjective and hard to codify into a trading system. Traders using support and resistance levels and breakouts from those levels have more difficulty being consistent than traders using the other types of breakout.
The Donchian Channel breakouts are breakouts from a previous high / low range. For example a 50 bar Donchian Channel is formed by looking back over the last 50 price bars and finding the highest and lowest price over the past 50 bars. This high and low value is plotted on the chart at the current price bar. A breakout occurs when the price today rises above yesterday’s upper Donchian Channel line or drops below yesterday’s lower Donchian Channel line.
Donchian channels are much more useful in systematic trading than support and resistance because they are simple to codify, place into system rules and backtest. This approach clearly shows you when there’s a buildup of prices moving to higher highs or higher lows on intraday, daily, or weekly charts. For example, if today’s close is the highest over the last 50days, then you have a 50-day breakout.
An example of a 50 bar Donchian Channel breakout on the S&P500 chart is shown below:
The third type of breakout is the volatility breakout. This is when the price moves up or down at a rate that surpasses recent volatility levels. For example, if today’s close is more than three times yesterday’s average true range (ATR) above the previous close, then it’s considered a short-term volatility breakout. In a short-term volatility breakout system, you may choose either the day’s opening price or the previous day’s closing price as your entry trigger in trend trading.
When calculating volatility breakouts you can measure volatility by using the Average True Range indicator. . ATR refers to how much price moves outside the previous bar’s range. This is explained in detail in this post on the uses of Average True Range.
- Moving Averages: Convergence Divergence (MACD)
The MACD is an oscillating indicator—a line graph that shows fluctuation between two extremes—that measures both trend and momentum. Like the moving average, the signal line indicates the average difference between two moving averages, with a second “smoothing” line providing more details to give you a clearer picture of the trend.
A crossover of the MACD above the signal line points to an uptrend or a buy signal, but a crossover falling below the signal line may indicate a downtrend or a sell signal.
As illustrated at the bottom of the chart below, the MACD can do a good job of catching short to medium term trending moves:
- Relative Strength Index (RSI)
The Relative Strength Index (RSI) is one of the best complimentary indicators in trend trading, helping you track price movements over any given period. At the same time, the RSI gauges overbought (OB) and oversold (OS) conditions, which are valuable in giving warnings about potential price reversals. A stock with an RSI of 70 or more falls under the OB category, which may suggest that its current price rally is about to end, so a price decline may follow next. A stock with below-30 RSI is considered OS, suggesting that the price decline may be ending soon and give way for the price to recover.
This can be used in two ways for trend following systems. The first is as a short term timing indicator for your entry trigger. Once a trend is clearly established, entering on a short term oversold condition as measured by a short term RSI (say 5 bars) can give you an excellent entry price while the trend is still intact.
The second method of using the RSI is as a breakout condition. If a longer term RSI (say 30 bars) hits an overbought reading, this can indicate that a strong trend is in place, and stocks like this can remain overbought for quite some time as the trend continues.
- On-Balance Volume (OBV)
The OBV puts together information about trading price and volume and compiles it into a single line indicator to measure cumulative buying/selling pressure. The volume of a trading instrument with a higher closing price bar gets added to the OBV, while the volume of a lower closing price bar is subtracted from the OBV. You can then use the running total of volume to see when buyers are overcoming sellers and vice versa, which can then tell you when prices are likely to surge or drop.
Trend Trading Exit Strategies
As a trader, it’s vital that you know when to exit a trade so you can protect your capital and profit as well as cap any loss if the trade doesn’t work in your favor. Having an exit strategy is also helpful in keeping your emotions in check as you make trading decisions.
Here are some recommended exit strategies when you get into trend trading:
1. Stop-loss and take-profit In this strategy, you give specific orders to your broker at which exact price point you want to close your losing and profitable position. The vast majority of trend trading systems use a stop loss. The key most traders don’t understand is that a wide stop loss performs much better than a narrow stop loss. This is because a narrow stop loss gets hit much more often than a wide one. This locks in a loss more often and leads to long streaks of losing trades. Wider stops give a higher win rate and smoother equity curve!
Most trend trading systems do not use a profit target because the goal of trend following is to capture big trends – you can’t do that if you cap your profits with a profit target. HOWEVER, you can often do very well if you set a very high profit target to take you out on an unusually large and fast move. This is useful because it banks the profit rather than waiting for the move to reverse all the way back down to the trailing stop loss exit point.
2. Average True Range (ATR) Initial Stop Loss The ATR is a volatility calculator, showing you how far an asset moves on average during a specified time frame. You can use the ATR to determine when to issue a stop-loss order, which is usually placed some multiple of the ATR below the entry price. This normalises the width of the stop between instruments – stocks with higher volatility have a wider stop and stocks with lower volatility have a narrower stop as explained in this post about the Average True Range.
3. Support and Resistance This approach involves setting a stop or limit near support (where a large number of traders are willing to buy) and resistance (where there are more sellers than buyers) levels. A rule of thumb is to set stop-loss orders slightly below the support level and slightly above the resistance level.
The difficulty with using support and resistance levels in your trend trading system is that they are very subjective and hard (impossible) to backtest properly. I much prefer to use stop losses based on Average True Range as explained above because these can be rigorously and objectively backtested to build confidence in them.
Some traders will use overhead resistance to exit trades anticipating that the trade will not be able to push through the resistance. With trend following, this is typically a huge mistake because you need to give your trend trades the benefit of the doubt. We can never predict just how far a trend will travel and exiting just because it approaches a historical resistance level will limit the size of your winning trades.
4. Trend weakness As the name implies, you use a trend weakness as a signal to exit trade. You may, for example, exit based on moving averages—once a price crosses from one moving average line to the other, you may take it as a signal to close the position due to shifting price trends.
Exiting when the price (or a short term moving average) crosses below the long term moving average is a good trend following exit provided you use a sufficiently long term moving average (say 150-200 bars). Shorter term moving averages (say 30-50 bars) will get you out of your trade too quickly and thereby limit the size of your winning trades… resulting in lower profitability of your trading system.
5. Exiting when entry criteria disappearsThis exit strategy suggests that the best time to get out of a winning trade is when the reason you’ve entered a particular position is no longer present. For example, you may have entered a position in a bullish market, but market conditions may turn bearish, so you take the change as a signal to give up trade. Since this approach is quite subjective in nature, it’s best to be cautious in relying solely on this exit method unless it can be quantified into an objective rule.
One way to do this objectively would be to exit your trade if the trend filter is no longer showing that the trend is in place. If this is true, then the trend may have finished and exiting may be a good idea.
All of these rules and ideas should be thoroughly backtested before trading them because each market and system behaves slightly differently and there is no one universal best set of trend trading rules.
Trend Trading Mistakes and How to Avoid Them
Mistake #1—Focusing only on the short-term Trend trading requires identifying and following an established market trend, making it a long-term trading strategy rather than a short-term one. Needless to say, paying attention to short-term trends may not give you a good reward:risk ratio.
How to fix it: Go for long-term strategies that give you enough time to make profit from winning trades and bounce back from unsuccessful ones.
Mistake #2—Not understanding diversification This is when you’d rather limit your trading to one or two well-performing stocks rather than a bigger stock portfolio, which reduces the likelihood of generating returns that exceed your benchmark.
How to fix it: Avoid allocating more than 5% to 10% of your portfolio to any one trade and holding a diversified portfolio of trend trading positions.
Mistake #3—Not understanding long/short bias You’re in a long position when you buy/own a stock that you think will have its value increased in the future. On the other hand, you’re in a short position when you sell assets that you do not own, hoping to buy them back when the price goes down. The problem arises when you hold either too many long or too many short biases, hoping to ride the potential upside and downside in price moves.
How to fix it: Aim for the right balance of taking both long and short positions. Trend following stocks on the long side is a great strategy most of the time, but when the bull market turns it can suffer large drawdowns. The solution is to combine long side trend following with a short side system that can profit when the long side trend trading system is losing money.
Mistake #4—Ignoring market conditions The high volatility and downward bias of most stocks in a bear market make it very difficult to profit on the long side with trend following. Continuing to buy breakouts hoping they turn into a solid long term trend while the broader market falls is usually a losing strategy.
How to fix it: Use a market filter, such as the 200-day moving average on the S&P 500, to know when the market is doing well or otherwise. Taking trend trades only in the direction of the broader market increases your chances of success and reduces your likely drawdown. As always, backtest your market filter to ensure it adds value for your system.
Mistake #5—Trading against the trends instead of with the trends
You’ll find the momentum of the market working for you when there’s historical basis for that directional movement, which is what trend trading is all about. Conversely, the push isn’t as favorable when you counter the trend since market movements become less predictable.
How to fix it: Always analyze and follow the trend in the stock or instrument you are trading using technical indicators, so you can manage your trades properly. My preferred approach is to use a trading system to define every decision that I make in my trading. A trend trading system should have a strict trend filter to ensure that you are only trading in the direction of the primary trend of the instrument. Don’t try to catch a brand new trend right at the beginning because that is a low probability trade. You will have far more success if you employ a strict trend filter that only allows you to trade once a trend has proven itself!
What Does A Successful Trend Trade Look Like?
As an example of how a trader may benefit from one of these trades, let’s say you entered Incitec Pivot (IPL – Australian stock shown in the chart above) on a 200 day breakout on 24 Dec 2006 at $0.79 with a 3 ATR initial stop at $0.75 and risked 1% of your $100,000 account on the trade. You then held the trade and used the 200 day moving average as a trailing exit point which kept you in the trade until 11 August 2008 at $6.23.
On the above trade, risking 1% of your hypothetical $100K account you would have risked $1000 on the trade, which would have allowed you to purchase 25000 shares (Number of shares = Dollar Risk / Risk per share = $1000/($0.79-$0.75)). This would give a position size of $19,750.
According to the above example, when the position was closed the shares had appreciated to $6.23 per share, giving you a total profit of $5.44 per share or $136,000 PROFIT. This translates to a 136 times return on your initial $1000 risk.
Warning: This trade is a hand picked example and is not typical. There are no guarantees you will get trades like this. However, these monster trades can come along every so often though, and this strategy is a good way to profit from them.
Trend trading systems which have the potential to capture monster trades like this one are discussed more extensively in our Trading Systems section.
What Trend Trading Software Do You Need?
To explore a trend trading strategy and ultimately develop a trend trading system, you will need a charting package, daily market data covering the markets you intend to trade and software capable of backtesting and optimizing your trading strategy.
If you are just getting started you do not have these packages, I recommend you use Amibroker to display your charts, backtest your trading system and manage your trades. Amibroker is the most powerful and best value backtesting software on the market.
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More Articles on Trend Trading
- 14 Global Stock Markets Tested for Trend Trading
- Can Trend Trading Make a Lot of Money?
- Why Trend Following Stocks Is A Great Trading Strategy
- How long do you need to hold trades for long term trend following systems?
- Should I go live with a long-only stock trading system when a market correction is expected?
- 5 Steps to capture the next big stock market move with trend following
- Are you entering stock trends too early?
- Can I capture more profits in a trend using Parabolic SAR as an exit?
- Learn Stock Trading | The Definitive Guide To Stock Market Terms
- Trading Books: ‘Trend Following: How Great Traders Make Millions in Up or Down Markets’ by Michael Covel
- Trading Books: ‘Trend Trading For A Living: Learn the Skills and Gain the Confidence to Trade for a Living’ by Thomas K. Carr
- Trading Books: ‘Following The Trend: Diversified Managed Futures Trading’ by Andreas F. Clenow
Conclusion on Trend Trading
In conclusion, trend trading is an exceptional approach to capturing significant profits from market movements while minimizing the time spent monitoring the markets. By identifying and capitalizing on trends, trend traders can benefit from various asset classes, including stocks, futures, and forex. This trading style relies on strong risk control, adequate diversification, and the discipline to adhere to a proven system.
Throughout this blog post, we have delved into the different aspects of trend trading, discussing its core components, strategies, indicators, and exit plans. We have also explored the role of risk management, leverage, and margins in this trading approach. While trend trading can be emotionally challenging, it remains a viable option for those who can balance their day jobs with this systematic approach.
Additionally, we have shed light on common trend trading mistakes and how to avoid them, highlighting the importance of using suitable software to enhance one’s trading performance. Ultimately, trend trading can be a highly rewarding and profitable endeavor for those willing to invest the time and effort required to master the art of riding market trends.
Join The Trader Success System for a Complete Trading Education
In addition to learning about trend trading, it is essential for traders to explore other trading methodologies to diversify their skills and maximize their potential for success. The Trader Success System is a comprehensive program designed to teach you not only about trend trading but also mean reversion and short selling strategies. By joining this system, you will gain access to expert guidance and valuable resources that will help you master these trading techniques, improving your overall trading performance.
Mean Reversion and Short Selling Systems
Mean reversion trading focuses on identifying assets that have deviated significantly from their historical averages, with the expectation that they will eventually revert to their mean. This approach offers excellent opportunities to profit from market corrections and overreactions. Short selling, on the other hand, is a trading strategy that allows you to profit from declining asset prices by borrowing and selling an asset, then repurchasing it at a lower price to return it to the lender. These two strategies, combined with trend trading, can provide a well-rounded trading portfolio.
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The Trader Success System will guide you through the process of backtesting, optimizing, and deploying a diversified portfolio of trading systems. Backtesting is the practice of applying your trading strategies to historical data to evaluate their effectiveness. Optimization involves fine-tuning your strategies to maximize their potential for profit while minimizing risk. Finally, deploying a diversified portfolio of trading systems ensures that you are well-positioned to capture gains from various market conditions and asset classes.
Advantages of Joining The Trader Success System
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Frequently Asked Questions about Trend Trading
What is a trend trading?
Trend trading, also known as trend following, is a trading strategy that focuses on identifying and capitalizing on the direction of a market’s movement – whether it’s going up (bullish trend) or down (bearish trend). The idea is simple: you jump into a stock (or any asset) that’s trending, ride the trend as long as it lasts, and exit when the trend reverses.
Here’s how it works:
- Identify the Trend: Use technical indicators like moving averages or price breakouts to determine if a stock is trending up or down. For example, if the price is above the 50-day moving average, it’s likely in an uptrend.
- Enter the Trade: Once a trend is confirmed, you enter the trade at a low-risk point, often when the trend is just beginning or gaining momentum.
- Set a Stop Loss: This protects you if the trend reverses unexpectedly. It’s a critical part of risk management.
- Let Profits Run: Unlike other strategies, trend trading doesn’t use profit targets. Instead, you hold the position as long as the trend continues, maximizing gains.
- Exit When the Trend Ends: When the trend bends and starts reversing, you sell to lock in your profits.
The beauty of trend trading is its simplicity and adaptability – It works across stocks, forex, futures, and more. It’s not emotionally easy, though, as it requires patience and discipline to stick with the system, even through losses
Is trend trading profitable?
Trend trading can absolutely be profitable, but it requires discipline, patience, and a solid system. The key to its profitability lies in its ability to capture large trends that can significantly outweigh the smaller losses you might incur along the way. Here’s why it works:
- Big Wins, Small Losses: Trend following systems typically have a low win rate – only about 30-50% of trades are winners – but the winners are much larger than the losers. This imbalance is what drives profitability.
- Works Across Markets: Trend trading is versatile and has been shown to work across various asset classes (stocks, commodities, forex, crypto) and timeframes. This adaptability makes it a robust strategy.
- Low Time Commitment: With a simple trend-following system, you can trade effectively with just 30-60 minutes a day, making it ideal for those with other commitments.
- Psychological Challenges: It’s not easy emotionally because you’ll face frequent losses and long periods of drawdown. However, sticking to the system is crucial for long-term success.
The bottom line? Trend trading works, but it’s not for everyone. It’s about following the system, managing risk, and staying patient through the ups and downs. If you’re willing to commit to the process, it can be a game-changer.
What is trend following trading?
Trend following trading, also called trend trading, is a strategy where you aim to profit by identifying and riding the direction of a market’s movement – whether it’s going up (an uptrend) or down (a downtrend). The core idea is simple: you follow the trend until it ends, capturing a significant portion of the price movement along the way.
Here’s how it works:
- Identify the Trend: Use tools like moving averages, breakouts, or other technical indicators to determine if a stock is trending up or down.
- Enter the Trade: Once a trend is confirmed, you enter the trade, often at a low-risk point, like when the trend is gaining momentum.
- Set a Stop Loss: This is crucial for risk management. If the trend reverses, the stop loss gets you out quickly to limit losses.
- Ride the Trend: The goal is to stay in the trade as long as the trend continues, letting profits grow. This requires patience and discipline.
- Exit When the Trend Ends: When the trend bends and starts reversing, you exit to lock in your gains.
The beauty of trend following is its simplicity and adaptability – it works across various markets and timeframes. However, it’s not emotionally easy, as it involves frequent small losses and long periods of waiting for trends to develop. But if you stick to the system, it can be incredibly rewarding over time
How do you determine trend trading?
Determining trend trading involves identifying whether a stock (or any asset) is in an uptrend, downtrend, or moving sideways. The goal is to spot a clear trend and then ride it for as long as it lasts. Here’s how you can do it:
- Use Moving Averages: A simple way to identify trends is by looking at moving averages. For example, if the price is above both the 50-day and 200-day moving averages, it’s likely in an uptrend. Conversely, if it’s below both, it’s in a downtrend.
- Breakouts: A trend often begins when the price breaks out of a significant level, like a previous high or low. Watching for these breakouts can signal the start of a new trend. For example buying when there is a new 200 day highest close.
- Bollinger Bands: These combine trend and volatility. If the price hits the upper band, it suggests an upward trend, while hitting the lower band indicates a downward trend.
- Trend Strength: Count the number of times the price crosses above and below a moving average. Fewer crossovers typically indicate a stronger trend, while frequent crossovers suggest a choppy, non-trending market.
- Linear Regression: A positive slope in a linear regression line over a set period indicates an uptrend, while a negative slope suggests a downtrend.
The key is to use these tools systematically, rather than relying on gut feel or news. Subtle changes can make a huge difference in profitability, so be sure to backtest your rules on your chosen market.
What are trend trading strategies?
Trend trading strategies are systematic approaches designed to identify and profit from market trends – whether prices are moving up (uptrend) or down (downtrend). These strategies rely on technical indicators and predefined rules to enter and exit trades. Here are some common trend trading strategies:
- Moving Averages: Use simple or exponential moving averages to identify trends. For example, if the price is above the 50-day and 200-day moving averages, it signals an uptrend. Crossovers, like the 50-day moving above the 200-day (golden cross), can also confirm trends.
- Breakouts: Enter trades when the price breaks above resistance or below support levels. Breakouts often signal the start of a new trend.
- Bollinger Bands: Combine trend and volatility. If the price hits the upper band, it suggests an uptrend, the lower band indicates a downtrend. This helps confirm the strength of a trend.
- Rate of Change (ROC): Measures the speed of price movement. A high ROC can indicate a strong trend, and it can also be used to rank stocks by trend strength.
- Trend Filters: Combine multiple indicators, like ensuring the price is above both the 50-day and 200-day moving averages, to confirm the trend direction.
Each strategy requires discipline and backtesting to ensure it aligns with your trading goals.
What is counter-trend trading?
Counter-trend trading is a strategy where you trade against the prevailing trend, aiming to profit from short-term price reversals or pullbacks. Essentially, you’re looking for moments when the price becomes overstretched or overbought in an uptrend, or oversold in a downtrend, and betting that it will “snap back” toward the mean or equilibrium.
Here’s how it works:
- Identify the Primary Trend: First, determine the overall trend using tools like moving averages. For example, if the 20-period moving average is below the 200-day moving average, the primary trend is down.
- Spot Overextensions: Use indicators like the Relative Strength Index (RSI) to identify when the price is overbought (too high) or oversold (too low). For instance, a two-period RSI can highlight short-term extremes in price movement.
- Trade in the Direction of the Snapback: If the primary trend is down, you’d look for overextensions upward and short the stock, expecting it to revert downward. If the trend is up, you’d look for overextensions downward and go long, expecting a bounce back up.
- Risk Management: Counter-trend trading can be risky because you’re going against the dominant market direction. Tight stop losses and disciplined position sizing are critical.
This strategy is often used in mean reversion systems, where the goal is to exploit temporary deviations from the trend.
Does trend trading still work?
Yes, trend trading still works, and it works across multiple markets, timeframes, and asset classes. The key is that trends are a fundamental feature of markets, driven by shifts in supply, demand, and sentiment. As long as markets exist, trends will form, and trend trading will remain a viable strategy.
Here’s why it continues to work:
- Universal Market Behavior: Trends occur in stocks, futures, forex, and even crypto markets. The nature of these trends may vary, but the principles of trend following remain robust across all of them.
- Proven Over Decades: Trend following has been successful for decades, with many traders and funds demonstrating consistent profitability using this approach. It’s not a fad – it’s a time-tested strategy.
- Systematic and Objective: Trend trading relies on clear, rule-based systems, which removes emotional decision-making. This systematic approach helps traders stick to their strategy even during challenging periods.
- Adaptability: A good trend trading system can work across different markets with little to no modification, making it highly versatile.
That said, it’s not easy. Trend trading requires patience, discipline, and the ability to endure frequent small losses while waiting for big trends to develop. But if you stick to the process and manage risk effectively, it remains a powerful and profitable strategy.
How to do trend trading?
Trend trading is all about systematically identifying and riding market trends for as long as they last. Here’s a step-by-step guide to get started:
- Identify the Trend: Use tools like moving averages (e.g., 50-day and 200-day) to confirm if the market is trending up or down. For example, if the price is above both moving averages, it’s likely in an uptrend. Breakouts above resistance levels can also signal the start of a trend.
- Set Entry Rules: Define clear criteria for entering a trade. For instance, you might enter when the price breaks above a recent high (e.g. a new 50 day highest close) or when a moving average crossover occurs (e.g., the 50-day moving average crossing above the 200-day).
- Risk Management: Determine your position size and set a stop loss to limit potential losses. A common method is placing the stop loss below a recent swing low in an uptrend or above a swing high in a downtrend. Position size your trades so you risk is 0.5 – 1% of your account to keep your drawdowns manageable.
- Let Profits Run: Trend trading relies on capturing large moves, so avoid setting profit targets. Instead, stay in the trade as long as the trend continues. Use trailing stops (10-30% wide; or 4-8 ATR to capture long term trends) or exit rules based on indicators like moving averages to lock in profits when the trend reverses.
- Diversify and Stay Disciplined: Trade across multiple markets or stocks (my stock trend trading systems hold 20-25 positions at a time) to reduce risk and stick to your system, even during drawdowns. Trend trading requires patience and emotional resilience.
How to do trend following trading?
Trend following trading is a systematic approach to profiting from sustained price movements in the market. Here’s how you can do it step-by-step:
- Set Up Your System: Define the conditions under which you’ll consider taking a trade. For example, you might only trade stocks that are above their 200-day moving average, which indicates an uptrend.
- Entry Trigger: Decide on a specific rule for entering trades. A common trigger is when the price breaks above a recent high or when a shorter moving average (e.g., 50-day) crosses above a longer one (e.g., 200-day).
- Initial Stop Loss: Set a stop loss to protect your capital. This could be placed below a recent swing low in an uptrend or above a swing high in a downtrend. The goal is to limit losses if the trend doesn’t materialize.
- Exit Rules: Use trailing stops or exit when the trend reverses. For instance, you might exit when the price falls below a moving average or breaks a trendline. The idea is to stay in the trade as long as the trend continues and exit when it ends.
- Money Management: Determine your position size based on your risk tolerance. For example, you might risk 0.5 – 1% of your account on each trade to ensure no single loss significantly impacts your portfolio.
- Diversify: Trade across multiple markets or stocks to spread risk and increase your chances of catching trends.
The key to success is sticking to your system, even during losing streaks, and letting profits run when trends develop.
What is the best trend trading strategy?
There isn’t a single “best” trend trading strategy – it depends on your trading goals, timeframe, and risk tolerance. However, one of the most effective and widely used strategies involves moving averages as both a trend filter and a signal for entries and exits. Here’s why and how it works:
- Trend Filter: Use a long-term moving average, like the 200-day, to determine the market’s direction. If the price is above the 200-day moving average, the trend is up, and you focus on long trades. If it’s below, the trend is down, and you focus on short trades.
- Entry Signal: A common approach is to use a moving average crossover, such as the 50-day crossing above the 200-day (a “Golden Cross”), as a bullish entry signal. Conversely, the 50-day crossing below the 200-day (a “Death Cross”) signals a bearish trend.
- Exit Signal: Use the price closing below the 200-day moving average as a fail-safe exit. This keeps you in the trend for as long as possible while protecting you when the trend reverses.
This strategy is simple, robust, and works across multiple markets and timeframes. That said, it’s critical to backtest and optimize these rules for your specific trading system.
Does trend-following work on stocks?
Yes, trend-following absolutely works on stocks, and it’s one of my favorite trading strategies. I’ve personally used it for over 20 years and found it to be consistently profitable. The beauty of trend-following is its simplicity – it doesn’t require complex analysis or constant monitoring, making it ideal even if you have a day job or other commitments.
Here’s why it works:
- Trends Exist in Stocks: Stock prices often trend due to changing fundamentals, market sentiment, or company management decisions. For example, when a company’s growth accelerates, its stock can trend upward for months or even years.
- Emotional Discipline: Trend-following removes emotion from trading decisions. By following a systematic approach, you can ride trends without second-guessing yourself, which is critical since most people struggle with patience and discipline.
- Profit from Big Moves: The strategy captures large price moves, which can offset the many small losses that are part of trend-following. For instance, I’ve seen trends that lasted years and delivered returns of hundreds or even thousands of percent.
What is an example of trend-following?
A classic example of trend-following is using moving averages to identify and ride trends. Here’s a simple system:
- Entry Rule: Buy a stock when its closing price is above both the 50-day and 200-day moving averages. This indicates the stock is in an upward trend.
- Stop Loss: Place a stop loss 20% below your entry price to protect your capital if the trade goes against you.
- Exit Rule: Use a 25% trailing stop. As the stock price rises, your exit point moves up with it. If the stock falls 25% from its highest point, you sell to lock in profits.
For example, I once bought a stock at $7 per share when it started trending up. Over time, it climbed to $140 per share before the trend reversed, and I exited. That’s a 20x return on a single trade! While not every trade will be this successful, the key is that big winners like this can more than offset the frequent small losses typical of trend-following systems.
This approach works because it’s systematic, unemotional, and lets you capture the middle of big trends.
What are trends in stocks?
In stocks, trends are sustained price movements in a single direction (either up or down) over a period of time. They’re essentially the heartbeat of the market and can be categorized into three main types based on their duration:
- Long-Term Trends: These last more than three months and are often driven by significant fundamental changes, like shifts in company earnings, industry growth, or macroeconomic factors like interest rates.
- Medium-Term Trends: These span one to three months and are often influenced by quarterly earnings reports, investor sentiment, or sector-specific news.
- Short-Term Trends: These last less than a week and are usually driven by immediate news events, technical factors, or short-term trading activity.
A trend is visually represented on a chart by a series of higher highs and higher lows in an uptrend, or lower highs and lower lows in a downtrend. Traders often use tools like trendlines, moving averages, or breakout patterns to identify and confirm trends.
The beauty of trends is that they reflect the collective psychology of the market (fear, greed, optimism, and pessimism) all rolled into price movements. And for traders, the goal is to identify these trends early, ride them for as long as they last, and exit when they reverse.
What are the benefits of trend-following?
Trend-following offers several compelling benefits, which is why it’s one of my all-time favorite trading strategies. Here’s why it works so well:
- Simplicity: Trend-following systems are straightforward, often based on just a few rules like moving averages or breakout levels. You don’t need to be a rocket scientist to implement them, which makes them accessible to traders at all levels.
- Emotional Discipline: By following a systematic approach, trend-following removes emotions from trading decisions. This is critical because emotions like fear and greed often lead to poor decisions. The system tells you when to enter, exit, and stay out, so you don’t second-guess yourself.
- Profit from Big Moves: Trend-following captures the middle of large price moves, which can deliver substantial profits. Even if 70% of trades are small losses, the big winners more than make up for it. For example, I’ve personally seen trends that lasted months or years, delivering returns of hundreds of percent.
- Adaptability: It works across different markets and conditions. Whether it’s a bull market, bear market, or even during crises like the Global Financial Crisis or COVID-19, trend-following has proven its resilience.
- Low Maintenance: Once set up, it doesn’t require constant monitoring. This makes it ideal for people with day jobs or other commitments.
The key is patience and sticking to the system, even when it feels uncomfortable.
What is the best timeframe for trend following?
There’s no single “best” timeframe for trend-following because it really depends on your goals, personality, and lifestyle. Each timeframe has its own advantages and trade-offs, so the key is finding what fits you best. Here’s a breakdown:
- Daily Timeframe: This is a sweet spot for many traders. It offers a good balance between capturing meaningful trends and avoiding excessive noise. Daily systems tend to be robust, with long-lasting edges, and you can backtest them over decades of data (e.g., back to 1950 in the US). Plus, they’re manageable since you can trade them with just 20-30 minutes a day.
- Weekly Timeframe: If you’re busy or prefer a lower-maintenance approach, weekly trend-following is brilliant. It eliminates much of the market noise and focuses on big macro trends. You’ll only need about 20 minutes a week to manage your trades, making it ideal for those with limited time. However, the give-back at the end of a trend can feel larger compared to daily systems.
- Intraday Timeframe: While possible, intraday trend-following is trickier. It requires more frequent monitoring, and the edges tend to erode faster. It’s also harder to backtest due to limited historical data.
Ultimately, the best approach is to diversify across timeframes. Combining daily, weekly, and even intraday systems can smooth your equity curve and reduce risk.
Why trend following does not work?
Trend-following works, but it’s not without challenges, and understanding why it might seem not to work is critical. Here are some reasons traders struggle with it:
- Frequent Small Losses: Trend-following systems often have a low win rate, sometimes as low as 30-40%. This can be psychologically tough because most trades are losses, and it feels counterintuitive to stick with a system that’s “wrong” so often. Many traders quit before the big winners come along to make up for those losses.
- Drawdowns: Trend-following can experience significant drawdowns, especially during market reversals or prolonged sideways markets. For example, after the 2008 crash, one of my systems stayed out of the market for nine months, which required immense patience. If you’re not prepared for these periods, it can feel like the system isn’t working.
- Late Entries and Exits: By design, trend-following systems enter after a trend is established and exit after it reverses. This means you’ll never catch the exact top or bottom, which can frustrate traders who want precision.
- Flat Markets: In choppy, range-bound markets, trend-following systems often get whipsawed – triggering entries and exits without capturing meaningful moves. This can lead to a series of small losses that test your resolve.
- Emotional Discipline: Trend-following requires unwavering faith in the system, even during tough periods. Many traders struggle to stick with it when the equity curve isn’t climbing steadily.
The key to overcoming these challenges is diversification (across markets, systems, and timeframes) and having a robust plan to manage risk and emotions.
Why are trends important in the stock market?
Trends are absolutely vital in the stock market because they represent the collective movement of prices over time, driven by changes in fundamentals, investor sentiment, and market dynamics. Here’s why they matter so much:
- Profit Opportunities: Trends allow traders to capture significant price movements. By identifying and riding trends, you can profit from both upward (bullish) and downward (bearish) movements. For example, I’ve seen stocks trend for months or even years, delivering returns of hundreds or thousands of percent.
- Market Psychology: Trends reflect the emotions of the market – fear, greed, optimism, and pessimism. Understanding trends helps traders align with the market’s sentiment rather than fighting it. This alignment is key to consistent profitability.
- Systematic Trading: Trends form the foundation of many systematic trading strategies, like trend-following. These strategies rely on trends to generate signals for entry and exit, removing emotional decision-making and improving discipline.
- Efficiency in Decision-Making: Trends simplify trading decisions. Instead of analyzing every minor price fluctuation, traders can focus on the broader direction of the market or a specific stock, making their approach more efficient.
- Risk Management: Trends also help traders manage risk. By following the trend, you avoid holding onto losing positions in the hope of a reversal and instead exit when the trend changes.
In short, trends are the lifeblood of trading and they’re where the money is made.
How long do stock trends last?
Stock trends can last anywhere from a few days to several years – it all depends on the type of trend and the underlying market conditions. Here’s a breakdown:
- Short-Term Trends: These might last a few days to a few weeks. They’re often driven by temporary news events, earnings reports, or short-term shifts in sentiment. While they can be profitable, they’re less predictable and more prone to reversals.
- Medium-Term Trends: These typically last several weeks to a few months. They’re often tied to broader market cycles or sector-specific movements. For example, a strong earnings season for tech stocks might drive a medium-term trend in that sector.
- Long-Term Trends: These can last for years and are where trend-following strategies really shine. Long-term trends are often driven by fundamental shifts, like a company’s rapid growth or a major technological breakthrough. For instance, I’ve seen stocks go from $7 to $150 over a year or more, delivering life-changing returns for traders who stayed in the trend.
The key is to align your trading system with the timeframe you’re targeting. Long-term trends require patience and discipline, while shorter trends demand quicker decision-making.
What is the downside of trend following?
Trend following and contrarian trading are fundamentally different approaches to profiting in the market, and they rely on opposite philosophies about price movement. Here’s the breakdown:
- Trend Following: This strategy involves buying stocks that are already moving up and selling them when they start moving down. The goal is to capture the “big chunk” in the middle of a trend. Trend followers don’t try to predict when a trend will start or end – they simply follow the price action. This approach typically results in a few very large winners and many small losses, as you cut losing trades quickly and let winners run. It’s all about riding sustained price movements and avoiding emotional decision-making.
- Contrarian Trading: Contrarian strategies, like mean reversion, focus on going against the prevailing market sentiment. You buy when prices have dropped significantly, expecting a bounce, or sell when prices have risen sharply, expecting a pullback. This approach often leads to many small winners and occasional larger losses, as you’re betting on temporary reversals rather than sustained trends.
The key difference lies in their relationship to market momentum: trend following thrives on it, while contrarian trading bets against it. Both can be profitable, but they require different mindsets, risk management, and systems.
What is the win rate for trend following strategy?
The win rate for a trend-following strategy typically ranges between 30% and 50%, depending on the specific system and market conditions. This might sound low, but it’s entirely normal and expected for this type of strategy. The key to profitability in trend-following isn’t a high win rate; the key to profitability is the size of the winners compared to the losers.
Here’s why this works:
- Big Winners, Small Losers: Trend-following systems are designed to cut losses quickly and let winners run. For example, a system might lose 1% on most trades but gain 10% or more on the occasional big winner. These large wins more than offset the frequent small losses.
- Psychological Challenge: A low win rate can be tough to handle emotionally. You might lose on 6 or 7 trades out of 10, but the 3 or 4 winners can deliver outsized returns if you stick to the system.
- Survivability: Systems with low win rates but high reward-to-risk ratios are often more robust because they don’t rely on being “right” all the time, which is critical in unpredictable markets.
If you’re considering trend-following, focus less on win rate and more on the overall profitability (expectancy) of the system.
Is trend trading the best strategy?
Trend trading is one of the best strategies for many traders, but whether it’s the best for you depends on your goals, personality, and trading style. Here’s why trend trading stands out:
- Proven Profitability: Trend trading has been consistently profitable across decades, asset classes, and market conditions. It works because trends exist due to shifts in fundamentals, sentiment, and market inefficiencies. I’ve personally used it for over 20 years with substantial success.
- Simplicity and Low Maintenance: A good trend-following system is simple to execute and doesn’t require constant monitoring. You can trade end-of-day data, making it ideal for those with full-time jobs or other commitments.
- Big Winners Offset Small Losses: Trend trading thrives on capturing large, sustained price moves while keeping losses small. Even with a win rate of 30-50%, the outsized winners make it highly profitable.
- Emotional Discipline: It removes human emotion from trading decisions, which is critical for long-term success. You follow the system, not your gut.
That said, it’s not for everyone. Trend trading requires patience, resilience, and the ability to handle frequent small losses. If you prefer high win rates or faster results, other strategies like mean reversion might suit you better.
Ultimately, the best strategy is one that aligns with your personality and goals. Join The Trader Success System to get immediate access to 20+ trading strategies that include trend following for ASX, US, TSX and Hong Kong stock markets.
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