Trend Trading – Chart Examples and Guiding Principles
Trend Trading Overview
Trend trading is the practice of riding a security during a strong move up or down. Now, what one person calls a trend can vary from trader to trader.
For example, a penny stock trader may expect a massive move higher of 20% or more intraday before considering a stock in an uptrend.
Conversely, a low volatility trader may need minor price expansion before declaring a new trend in play.
Trend Trading Indicators
When trading, the less subjectivity you have about the markets the better. Therefore, you can use technical indicators to gauge market trends.
As mentioned in the prior chart examples, you can use trendlines to clearly define the market trend. Now, this can still prove to be somewhat subjective as you are required to identify the start and end points for the lines.
For bullish trends, you want to connect the low points and high points to develop an up channel.
As the stock is on its upward trajectory, the stock should not breach the prior low on its way up.
To take it a step further, you can use trend channels. These channels create a clean parallel line. These channels will not allow you to create wedge patterns or diamond formations.
Slope of the Line
The other point to note, is you need to identify a minimum slope of the line which will trigger a trend for you.
A strong trend will have a slop north of 50 degrees to generate the level of an impulse move higher.
This is completely subjective, but just making the point if you are trend trading the move should be strong enough for you to care.
Moving averages are another great indicator you can use to measure the strength of a trend.
Now, you can take the simple approach of waiting to see if the stock is above or below its 200-day moving average. However, another approach is to look for a strong trend where the averages do not intersect on the way up. This spread of the averages shows you that the stock is trending hard for all periods (short and long).
The above chart has two moving averages the 10 and 20 EMA. You can see the level of backtesting the 10 has with the 20, which is a clear sign the stock is not trending hard.
The above chart is a clear example of when a stock is trending really hard. Notice how the averages do not cross at all and to add more validity to the trend, the averages are also far apart all the way down.
Just to level set your expectations, these sort of trends are hard to find. The sad thing is that when you find them, it's likely when you have not honored a stop and the market takes you for a ride.
Another indicator you can use to analyze the markets are momentum oscillators. These indicators have no upward or lower bound which allows the stock to just run.
The TRIX indicator is a momentum oscillator that moves above and below a zero line. In the next chart, we will cover a stock that is in a strong downtrend and the TRIX is just living below zero.
Now the TRIX does not react quickly because it smoothes out three exponential moving averages, so it's a great indicator for measuring trends.
Notice how as the stock moved lower the TRIX respects the zero line. Now, this does not mean there aren't moments when the TRIX breaks zero by a hair or two.
Remember, in the market rarely does the price action fit nicely into the box dictated by technical analysis books.
Trend Trading Examples
Here is a stock in a clear downtrend. You can see how the stock is making lower lows and lower highs.
Next up, a strong bullish uptrend with higher highs and higher lows.
Are you able to see the difference?
Can you see how the above chart lacks any trend. This is what we would call a choppy market or a security the lacks a clear trend.
Where Trend Trading Fails
Trend trading fails quite frankly when you get it wrong. It's not personal, but trend trading is pretty easy to identify on the chart.
So when it fails it's due to human error.
Not Honoring Your Stops
When you are trading a stock that is trending, it feels great. You don't have to do much and the money just flows into your account. However, if you jump into a trending stock at the time it reverses, you can find yourself in a pickle.
This is because being late to the party can lead to a nasty reversal as the stock could drop back down to its origination point.
So, you have to use your stops or the trending move will become your worst nightmare.
One last point on this. If you find yourself buying at a top of a strong trend, do not add to the position as it violates each swing low on the way back down. Just remember I said this to you if you find yourself in a jam.
In the above chart example, I'm just pointing out what happens if you were to buy support in a channel of a strong uptrend that fails.
As you can see, if you did not place a stop below the low of the test, things got ugly fast and in a hurry.
How Can Tradingsim Help?
If you are looking to practice trading trending stocks, it will come down to your entries, stops and the method of choice. Whether it's moving averages, channels or oscillators. You will need to master each method in order to develop an edge.
This is where you can use Tradingsim to practice with over 11,000 stocks and 1,000 ETFs.