Trend trading refers to placing trades based on the analysis of the direction or momentum of the asset. A trend is formed when the price moves either up or down. When it progresses upward, traders enter a long position. But when it is trending downward, they tend to get into short positions. In my years of experience in the stock market, I noticed that many traders are actually earning more than the average earning of mutual funds by just understanding the trend of the current market.
How to spot trending
First, it is necessary to understand that trend trading is anchored on the assumption that the security will continue moving in the direction it is currently running in. It is a risk the traders take so they use the stop loss and make- profit provisions to minimize the risks when a reversal occurs. It is a good strategy for both short, long term and intermediate traders.
It takes advantage of downtrends in a case where the price makes new lows or when it makes new highs.
It entails a series of higher swings and higher lows for an uptrend and lower swings and lower lows for a downtrend.
To emerge successfully, traders utilize tools such as moving averages, technical indicators, and trend lines to identify the signal and direction. They also make use of price action and technical tools in helping determine the direction when it is likely to make a shift.
The price action- helps traders determine the direction in which the price will be moving by observing the movement on charts. If the price is moving above the recent highs, it tells them that it is an uptrend. For this trend, the drop should stay above the previous low swings. (Higher highs and higher lows ). It indicates an overall upward trajectory even when the price moves up or down. The opposite is true for a downtrend. It is characterized by lower highs and lower lows. If this phenomenon is not observable, the trend will not be holding, and so the trader may not get interested in this trade.
Strategies for trend trading
Once a trend has been identified, a trader may use different strategies to place their trades. Price action and Indicators are the best strategies that can be deployed in this case. Also, the stop losses should be used in managing the risks. In the case of an uptrend, the stop loss should be placed slightly below the swing occurring before the trader’s entry or below the new support level. In the case of a downtrend, the stop loss should be placed above the newest resistance level.
A trader may also use moving averages to place their trades. It entails entering a long position as soon as the moving average (short term) crosses the long term moving average from above. The trader could also sale the asset when the long term moving average is crossed by an SMA from below. In a nutshell, the trader watches the price. So when they determine that it has crossed the MA from above, they buy the asset. Conversely, they will sell the asset if the price crosses the MA from below.
Moving averages can be used alongside other technical analysis in helping to filter out strategies. When the price increases and moves above the moving average, it indicates the presence of an uptrend. Similarly, when the asset’s price falls right below its moving average, it shows the presence of a downtrend.
Trend trading is characterized by many momentum strategies and indicators. A good example is when searching for an uptrend using relative strength index that signals exits and entries. If the RSI drops below 30 and rises above it, it is a good signal for a long position. The explanation is that the price was initially pulled back; however, it has started rising again so that it aligns itself with an overall uptrend. But when it rises above seventy or eighty and falls back, it calls for the trader to exit.
Trend traders watch for patterns such as triangles and flags to figure out the continuation of the current trend. If the price is forming a triangle or a flag so they will keep an eye on the price. If it breaks the pattern, it could be an indication of an uptrend. They may also look at breakout through resistance level to determine the direction of movement. Others may want to see the prices trading below or higher a specified moving average to determine the trend.
Identifying a trend reversal
Learning to identify a trend reversal is critical in stock trading. It helps in pinpointing areas where the price is likely to change.
The first thing that indicates a trend reversal is weaknesses in a trending move. For instance, if it is an uptrend, a strong trend will have more bullish candles than bearish candles. Also, the bullish candles will always be larger compared to the bearish. Besides, the bullish candle will be longer than the bearish and will close near the high. The opposite is true for an uptrend, and it implies that a reversal is in the offing.
So when you notice that the bullish candles are becoming less frequent and smaller compared to the bearish, it means that there is increasing pressure from sellers.
Retracement- it is another good sign of a changing trend. Typically, a healthy uptrend has more bullish candles and a few small bearish candles. Also, the retracement candles will close near the lows or the middle of the range. Larger bearish candles tell of increasing selling pressure. It is also a tell-tale sign that buyers are no longer willing to buy at a higher price.
Break of resistance or support area- a mature trend has a balance between buyers and sellers. The area of support is the last line of defense. When it is broken, the bull loses. Also, when the resistance is broken, the bears lose, and the bulls take full control. The more the support or resistance is tested, the more the likelihood that they will give in.
Lastly, you can also use other indicators such as timeframe structure and Bollinger bands to determine when the market trend is likely to reverse.
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