Trend trading strategies help identify the direction of the existing market trend. Trend trading strategy uses various technical indicators for trend identification and provides great results if implemented properly.
Trend traders use these technical indicators to understand the asset’s momentum, providing ideal entry and exit price levels. As the name suggests, trend trading follows a specific trend analysis, especially an existing trend, to avoid losing money rapidly.
Let us take into depth of Trend trading strategies.
What is trend trading?
Trend trading enables you to capture price fluctuations by analysing the stock’s momentum in the market. In trend trading, you follow a particular overall trend direction that the stock is moving in to place successful trade orders.
- You place a long position or entry order if the stock is moving in an overall upward trend direction
- You place an exit or short selling order if the stock is moving in an overall downward trend direction
You can identify a current trend by analyzing historical price data, trends and market momentum. You can predict markets with the help of these past performances and market price movements. As swing traders, you can develop trend trading strategies based on the belief that the trend will continue in its current form and not reverse. An uptrend will continue with rising prices, and a downtrend will continue with falling prices.
For example, if you are trading an ABC stock that opened at INR 50 and increased to INR 70, INR 75, and finally price rises to INR 85 during the day, it will indicate an uptrend and signal day traders to enter the market due to the expected continued uptrend. On the other hand, if the same stock opened at INR and fell to INR 45, INR 40 and finally INR 30, it will indicate a drastic downtrend and signal traders to exit the trade due to the expected continued downtrend.
What are the types of trends in stock market?
Trend traders identify trends existing in the market, which helps them determine if they should enter the market as a trend continues or exit if the trend is about to reverse. There are three types of trends:
When a stock price moves in an overall upward trend direction, it is known as an uptrend. Each successive stock price value is higher than the previous price action in an uptrend.
For example, if you are trading ABC stock which opened for INR 20 and moved to INR 24.5 during the day. The stock will continue to increase as each hour passes and reach a level of, let’s say, INR 30 just before the market closes. Trading this particular stock would mean you are trading an uptrend in the market as the overall price direction of the stock is upwards.
An uptrend always consists of higher highs and higher lows to keep the consistency of a market moving upward alive.
During an uptrend, technical traders try to make as much profit as possible through incremental prices by holding onto the stocks for a long time.
When a stock’s market price moves in an overall downward direction, it is a downtrend. Each successive stock price value is lower than the previous price action in a downtrend.
For example, let us assume that it is day 2 of trading the same ABC stock that we traded above. The stock opens at INR 28, indicating a downtrend as it opened below the previous day’s close. The stock will start moving downwards, from INR 28 to INR 25, and fall below INR 20 (let us say, INR 18). It indicates an overall downward price in the market where you can either exit the trade to cut your losses or apply a risk management strategy and place a short-selling order to trade the falling market.
A downtrend always consists of lower highs and lower lows to keep the consistency of a market moving downwards alive.
During a downtrend, trend traders try to make as much profit as possible by short selling and trading the falling markets. In short selling, traders borrow stocks and immediately sell them at the current price.
Later, when prices fall further, they buy back the shares and return them to the lender and keep the profit made from the decrease in prices. If traders wish to short-sell, a downtrend signals traders to exit the trade.
A range-bound trend, also known as a sideways trend, is a market momentum where a stock trades between a particular range, generally between the support and resistance price level.
- The support price level is where the falling prices stop falling and start rising
- The resistance price level is where the rising prices stop rising and start falling
You trade the stock based on its lowest and highest price levels in this particular sideways trend. For example, considering the example we have already discussed, the lowest price level, in this case, is INR 18 and INR 30 is the highest that the stock traded. You will place orders between these two price levels to trade a range-bound market. Ideally, you will place a buy order at the support level of INR 18 to maximize profits and a sell order at the resistance level of INR 30 to minimize losing opportunities.
5 Indicators You Can Use for Trend Trading
Now that we understand all types of trends in the market let us understand how to identify trends. Technical indicators help you identify strong market trends that you can use to place successful trade orders.
Let us discuss the four most popular trend trading indicators –
Moving Averages (MA)
Moving Averages is the simplest trend trading strategy that enables you to smooth out any irrelevant price fluctuation from the current price movements by taking an average of the same. You can take the average prices across different periods and compare them with the current price to analyse if the market is uptrend or downtrend.
- If the stock’s average price is near its current price, it indicates that the market moves along with the current trend.
- If the stock’s average price is far from its current price, it indicates that the market is not aligned with the current trend.
There are two types of moving averages –
- Simple Moving Average (SMA): The SMA is a trend following indicator that takes the sum of all the prices in the time and divides it by the total number of observations to conclude the stock’s average price. The most widely used SMA timeframes are 10-days, 50-days, 100-days and 200-days MAs. It places equal weight on all prices and is plotted as a line moving along the stock’s price chart to indicate the changes in the average price.
- Exponential Moving Average (EMA)
EMA is also a trend following indicator, a moving average that gives more weightage to the most recent prices and is more influenced by the new prices. You can calculate it by using the following formula-
EMA = Closing stock price*multiplier + EMA (previous day or SMA)*(1-multiplier)
Where the multiplier/weightage = 2/(number of periods + 1)
Moving Average Convergence Divergence (MACD) Crossover
In addition to the Moving Averages, the trend trading strategy is the MACD crossover that helps identify the change in the prevailing trend in the market.
It consists of a MACD line calculated by subtracting the 26-day EMA from the 12-day EMA and a signal line which is the nine-day EMA of the MACD line itself.
- When you see the MACD line crossing the signal line from above, it indicates a bullish trend in the market and signals traders to place buy orders as an uptrend is expected
- When you observe the MACD line crossing the signal line from below, it indicates a bearish trend in the market and signals traders to place sell orders as a downtrend is expected
Average Directional Index (ADX)
ADX is a technical analysis tool and trading strategy also used as one of the trading strategies that help determine a trend’s strength. It is a trend-following indicator that provides values between 0 and 100. Any value above 75 indicates an extremely strong trend, and any value below 25 indicates an extremely weak trend.
A Supertrend is a trend indicator that provides trend traders with ideal buy or sells price levels in a market trending in a particular direction. It is plotted as dots above or below the closing stock prices, indicating current trends.
It indicates a buy signal whenever the Supertrend dots are placed below the stock’s closing price as it signals an expected uptrend in the market. Sell signals are identified when the Supertrend dots are placed above the closing price, expecting a market downtrend.
Relative Strength Index (RSI)
The Relative Strength Index is a trend following indicator that helps you measure how much the prices have changed in the market. It helps identify overbought and oversold market conditions that provide ideal entry or exit signals.
RSI gives values between 0 to 100, where above 70 indicates an overbought market condition and below 30 indicates an oversold market condition.
- Overbought market signals traders to exit the trade as the market is expected to fall in the future
- Oversold signals indicate traders enter the trade as the market is expected to rise in the future
Trend trading strategies significantly help you identify the ideal entry and exit levels in the stock market. It is a type of trading that has been in existence for as long as possible, is still widely used and will exist as long as markets do. You can confirm trends in the market by combing two or more trend trading strategies that we have discussed to help place orders successfully.
Does trend trading still work?
Yes, trend trading works wonders when applied cautiously. Using two or more technical indicators together, you can identify the ideal time to enter or exit a trade and place successful orders accordingly.
How do you trade a trend day?
While trading a trend day, you have to determine the direction of the market momentum. You can do this efficiently by using technical indicators — Moving averages, Moving Average Convergence Divergence, Average Directional Index, and Reflective Strength Index.
When a trend day is moving upwards, you can place a long position or buy orders, and when it is moving downwards, you can place short or sell orders.
What is the best trend trading indicator for a trend trader?
The (ADX) Average Directional Index indicator is the best in most cases. It shows when the price is trending strongly and becomes the ultimate indicator in many cases. However, the Moving Averages (MA) are the simplest and most widely used trend indicators. They make the process of identifying trends easier.
How do you confirm trends for trend trading?
To confirm trends for trend trading, you have to analyze the price chart deeply. You have to find trendlines. Trendlines can be found in the chart, and they make the connection between highs and lows in a series. When you see a trendline moving upwards, you have an uptrend, and when you see it moving downwards, it is a downtrend. That is how you usually confirm trends.