The share market is a place where people can buy shares of a company and sell them at a profit, sometime in the future. Then there is intraday trading, where the buying and selling happen within a day. While the share market is ideal for people who don’t mind staying invested for the long-term, short-term investors typically dominate the trading market. But such investors need to form various strategies and make their trades based on information derived from technical charts and patterns and trends. This article explains trend trading in detail.
What is trend trading?
Trend trading is defined as a market trading strategy, involving the use of various technical indicators that help identify the market momentum direction. The strategy is founded on the premise that the trading market has an element of predictability, which traders can analyse and use to their advantage. As a trader, you can predict and analyse how your trade will pan out based on price movements, historical trends, past performance and other such elements.
Trend traders attempt to capture gains by analysing the momentum of an asset in a particular direction. When the price of an asset moves steadily up or down, a trend is said to be forming. So when a security is trending upward, a trend trader is more likely to take a long position.
Decoding trend trading
The basis of all trend trading strategies is the assumption that a security will continue moving in the same direction in which it is trending currently. Traders utilising this strategy often operate on the take-profit or stop-loss basis, so that they can lock in profits or avoid massive losses, in case the trend reverses. Along with several technical tools, trend traders also use price action to determine a trend’s direction and when it may potentially shift.
Identifying trends – types and examples
Trend trading strategies can help traders identify trends so early in a trade, that they can exit the market before the trend reverses. Trends are typically categorised into three types – uptrends, downtrends and sideways trends.
When the market price of a trade starts increasing in value, you can say that an uptrend is forming. Traders hoping to take advantage of an uptrend tend to enter a long position when the market begins to reach increasingly high price levels. For instance, if the share price of a company increases by Rs. 20, then declines by Rs. 10, and then rises by Rs. 25 and falls again by Rs. 15; the share price would be deemed to be in an uptrend since it is making both, higher highs as well as higher lows.
A downtrend begins to form when the market price of a security starts decreasing in value. In this case, trend traders would usually enter a short position, i.e., when the price of the security starts going down, typically to the lowest possible point. For instance, if the price of the security decreases by Rs. 50, then increases by Rs. 25, and then it falls again by Rs. 40, before rising by Rs. 10, you can say a downtrend is forming. As such, in a downtrend, the stock price falls to lower lows and lower highs.
3. Sideways trend
There are times when the market price of securities remains static. The price neither reaches higher price points or lower price points. Such a trend is known as a sideways trend. Most people involved in trend trading tend to ignore these trends. However, scalpers, seeking to benefit from extremely short-term movements in the market, tend to take advantage of a sideways trend.
Trend trading timeframe and traders
Although it is deemed as a mid to long-term strategy, trend trading can cover any timeframe. It all depends on how long a specific trend lasts. This trading strategy is popular among all kinds of traders – short, intermediate and long term, as well as swing and position traders. Swing traders are people who identify trends and ride it from the beginning to the end. In contrast, position traders tend to hold a trade throughout a prevailing trend by ignoring daily fluctuations.
Trend trading strategies and indicators
Now that we know trend trading meaning and types let’s take a look at the strategies or indicators that traders use to identify trends. They are as under
1. The MACD trading indicator
The Moving Average Convergence Divergence (MACD) indicator helps traders find the average price of a security over a specific timeframe. The MACD trend trading strategy is one in which traders enter a long position, at a time when a short-term moving average crosses over the longer-term moving average. Conversely, traders may enter a short position if a short-term moving average crosses below the longer-term moving average. Traders generally combine the MA trend trading methods with other forms of technical analysis, which helps them filter out the signals. They may even look at price action to determine a trend.
Furthermore, moving averages also help with trend analysis. For instance, when the price of a security, is above the moving average, it indicates the presence of an uptrend. In contrast, when the price of the security is below the moving average, it shows the presence of a downtrend.
2. The RSI trading indicator
The Relative Strength Index trend trading system is a strategy that helps identify the momentum of prices as well as oversold and overbought signals. It does this by observing the average profits and losses over a few specific periods, typically 14 periods, determining whether the movements of prices was positive or negative. RSI is usually presented as a percentage, fluctuating on a scale from zero to 100. The market is said to be overbought and oversold when the indicator moves above 70 and below 30, respectively. Trend traders use these levels as signals stating that a trend may be inching close to its maturity.
3. The ADX indicator
Trend traders also leverage the Average Directional Index or ADX momentum trend trading strategies to analyse trends. The ADX indicator primarily measures how strong a given trend it. It enables traders to estimate the security’s price strength in both, positive as well as negative directions. The line on the ADX indicator fluctuates between zero and 100. If the indicator shows values from 25 to 100, it means a strong trend is occurring, whereas if values fall below 25, it indicates a weak trend.
Now that you know what trend trading is and the various strategies, you can apply them to your trades. However, you must master your strategies before applying them. Remember to use all the weapons you have at your disposal to analyse the trends – from research data to charts and candlestick patterns. You should also determine the markets in which to conduct your trades as well as your risk appetite. Implementing a risk management strategy is just as crucial as implementing any trading strategy. For more information on trend trading systems, reach out to an Angel One advisor.