How to Profit From Trend Trading
By Robert Colville on
March 3, 2013
Trend Trading: Buy in an uptrend and sell in a downtrend to have the odds in your favour. That is the long and short of it!
Ever heard the expression:
“The trend is your friend until the end when it bends”?
While it may serve to be little more than a cliché in and amongst the more seasoned professional trading circles, it does not take away from the importance of actually putting into practise with trend trading – especially if you are new to the art of trading financial markets.
Buying or going ‘long’ in an uptrend and selling (‘shorting’) in a down trend is far more likely to contribute to a successful trade outcome, because you are following the overriding sentiment which is governing the movement of price action.
Very much like a river gently ebbing and flowing down the hillside, the market will generally trickle in the pathway of least resistance and trading against the trend is very much like trying to swim up river with the odds being very unlikely to be in your favour.
Suffice to say, in a bullish market, you there will inevitably be an uptrend and, in contrast in a bearish market, a downtrend.
So how do we identify a trending market? When trend trading, all we need to do is identify key swings in the market, also known as ‘peaks’ and ‘troughs’
Reassuringly enough, you can do this very easily by looking at price action on its own, on any timeframe without having to bother with any indicators or so-called ‘EAs’. After all, indicators often are little more than a false economy as, while many may give the illusion of looking impressive in their complexity on the chart thus serving a ‘greater purpose’. However, most often over complicate the issue and actually cloud the trader’s judgement.
Trend trading: General characteristics of a trend
Trending markets by their very nature make strong moves in a given direction before a period of intermittent consolidation/retracement before continuing in the prevailing direction of the trend. The direction reflects the sentiment felt amongst the market participants – whether it is a market if buyers (a bull market) or one which is dominated by sellers (a bear market).
In a market dominated by buyers (bulls), the subsequent uptrend will have ‘higher highs’ and ‘higher lows’, also known as higher peaks and higher troughs.
It will be driven by momentum to the upside and will buyers will typically cause price action to extend to a point of perceive value for until profit taking takes place and the price retraces to a price point where ‘good’ value is perceived for buyers to come back into the market and cause price to rise and reach a new high. This is typically how a higher low is formed and, followed by a ‘higher high’.
Trend trading: How to identify a downtrend
Conversely in a market dominated by bears (sellers) the resulting downtrend will have lower peaks and lower troughs – also known as lower highs and lower lows.
Just like the case with an uptrend, it will be driven by bearish momentum to the downside causing price action to fall to a price of perceived value for the bears to unwind their positions and for buyers to come back into the market and cause price to rise and form a lower high at a price perceived as a good point for the sellers to form a ‘lower high’…just before the sellers come back into cause price to tumble again.
Trend trading: The best trends
The steeper the trend the better.
As traders, our primary objective is to make money and a decent percentage return after we have broken even. Obviously we want the market to prove our trading decision ‘right’ or ‘wrong’ in the shortest possible time rather than being stuck in a lifeless laggard for weeks on end!
Therefore, we want speed and momentum to drive our trade to our target as quickly as possible and steep upward and downward trends will enable us to profit from faster movement, in our favour, quicker.
To objectively see whether we are in a trending market and we have both speed and momentum on side, then we can add the following filters simply add the following requirement:
Uptrend: For the price action to be above the 20ema, and for the 20ema to be above the 50ema…and for the 50ema to be above the 200.
Downtrend: For the price action to be below the 20ema, and for the 20ema to be below the 50ema…and for the 50ema to be below the 200ema.
Trend trading: When the trend starts to bend
It is quite easy to get an objective ‘heads up’ as to whether the trend in question is likely to continue – or not and, from reading price action, we can look out for clues which tell us that the trend is going to break down.
In an uptrend, which is making higher highs and higher lows – all we need is a ‘lower high’ to give us a warning sign that the bullish momentum is starting to slide and that the bears are creeping back into the market. This spells danger as it is more likely to reverse our trend than enable it to continue. It is therefore not advisable not to buy in the direction of the trend.
For a downtrend, the emergence of a higher low will spell danger for people looking to go short in a market which, until now, has been dominated by sellers and making subsequent lower highs and lower lows. It is a sign that the bears are starting to be superseded by the bulls who have made a return to the market. Again, this spells danger as it is more likely to reverse our trend than enable it to continue. It is therefore not advisable not to sell in the direction of the trend downward trend if higher low manifests itself.
Trend trading: Conclusion
To profit from trend trading…the clue is in the title “trend trading”! Trading with the trend will arm you a far higher degree of probability than if you are trying to swim upstream and counter-trend trade (by going against the trend).
Trading continuation trades with the trend not only provides you with an outcome with higher probability but also the frequency of opportunities is greater compared to trading key reversals in a range-bound market. That said, the reward risk profile is typically lower when trading with the trend (compared to key reversals) but the trade off is an outcome with heightened probability.
As markets only trend 25% of the time, it makes sense to have a strategy which will enable you to profit from ranging markets also, rather than simply declaring yourself as someone who trades trends only. Ranging markets are often underrated and as traders, we need to be combative and adapt to changing market conditions. There are highly profitable opportunities in both ranging and trending markets – just do not get suckered into choppy conditions.
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