Trend trading is a strategy that involves traders analyzing the direction of trends for financial instruments. When an asset is seeing an upward trend, traders would often look to enter a long position and buy. In the opposite scenario, when trend direction is downward, traders would go short and sell. Read on to learn more about trend trading, the various strategies involved, and to view examples from our Next Generation trading platform.
Trend following strategy
Trend traders create strategies that are developed based on analyzing the trends of an asset. A trend following strategy is based on the expectation that the direction of price will continue in its current form and the trend will not reverse. This means that if you are trading an uptrend, you could continue to hold your long position and watch the asset increase in value, while you could choose to sell your asset if the trend is going downward.
. Traders following the trend pattern would attempt to gain from the movement by entering a long position as the price level increases. When the trend is making higher highs and higher lows, then it is showing an uptrend.
When the price is decreasing in value. Traders could then go short and take a sell position as the trend is making lower lows and lower highs.
A sideways trend is when the price action is neither reaching lower or higher points. Generally, traders do not seek to make any gains with this type of trend, unless they are analyzing extremely short-term price movements, such as in a scalping strategy, for example.
It is important to understand the risks of trading with derivatives, such as recognizing that a trade position can result in gaining profit as much as a loss occurring if a trade does not go the intended way.
Traders can take advantage of customizable charts and drawing tools to highlight the price action and overall direction of a trend, which can be applied to multiple chart time frames. These features enable traders to take the quality of their analysis to an even higher level.
Trend following techniques can be used for strategies that concentrate on either short-term or long-term trends.
Short-term trend trading
Short-term traders such as day traders like to keep their eye on trends that arise throughout the day in short periods in order to try and benefit from short-term price fluctuations. There are a variety of popular strategies that intraday traders like to use, such as scalping, and there are also separate intraday trend following strategies.
Intraday trend trading
Intraday trend traders would usually hold positions until the end of each day. Therefore, day traders can analyze trends that are only active for a short period within the day, even for a few minutes or hours. Intraday trend following consists of analyzing the shorter-term fluctuations and movements in price. For example, if there is an uptrend during the day that consists of a series of movements creating higher relative highs and lows, then traders could place a trailing stop before the low and then at the next higher low, in the trend, in case the trend were to suddenly reverse. When following a downtrend, intraday trend following could be beneficial as this involves a short selling strategy, which is often used by short-term traders.
Long-term trend trading
Long-term trend trading involves holding on to a position for longer periods of time, often that is in an uptrend. This could be a few weeks, months, or even years. Long-term traders make decisions based on in-depth fundamental analysis that predominantly focuses on how the market will look in the future. When it comes to trend analysis, long-term traders are less concerned with the daily trend fluctuations and concentrate more on the longer-term trend and its influential factors.
One of the most popular trading strategies among long-term traders is position trading. This trading method enables trend traders to buy and hold a position for extended periods of time. Without concerning themselves with shorter-term trend movements, the focus is on the long-term objective. However, if short-term fluctuations potentially influence the long-term outlook of their position, then trend following is important and plays a significant role in attempting to attain long-term gains. In order to evaluate potential price trends on the market, it is common for position traders to focus more on fundamental analysis.
Popular trend trading indicators
When developing trend trading strategies, traders can benefit from a wide range of technical indicators. Below are a few examples of indicators that are popular amongst trend traders and can be applied to trading charts.
- Moving Average Convergence Divergence (MACD): this supports traders to identify the momentum of a market. It is an oscillating indicator that is effective for identifying new trends and deciphering if they are bullish or bearish.
- Relative Strength Index (RSI): an indicator that is used by traders to gauge the future direction of a market and to verify whether momentum is accelerating or decelerating. Traders also use this indicator to identify opportunities and to determine whether a stock is overbought or oversold (which could end up affecting the overall direction of their price trend).
- Parabolic SAR: also known as the ‘stop and reversal system’, this indicator helps traders to spot the current trend direction. It also helps with understanding the price direction of an asset and highlighting potential reversals.