Trend Trading Strategy: the investors’ key to big profits!

Trend trading can be very lucrative when the strategy is carried out to identify and take advantage of trends. So that is a longer term type of trading strategy. In its implementation, it is important not to pay great attention to outside factors, such as stocks being overextended, while the latter are following the uptrend.

In trend trading, no forecasting of markets or of price levels is necessary. In order to follow trends, it is important to stick to precise rules, without guessing and without any emotions. What really matters is the current market price, the volatility and the account’s equity level.

The initial risk rule is to know how many stocks should be bought or sold on the basis of the investor’s capital. Price changes may necessitate reduction or increase in an initial trade. The use of stop orders is highly recommended if adverse movements occur. Overall, if the trend is guessed correctly, the average profit per trade greatly exceeds the average loss per trade.

The human element is an essential component in this strategy. Discipline and control of emotions are mandatory. The strategy can be utilized in all asset classes, such as: stocks, exchange-traded funds, futures, commodities, options, bonds, currencies, etc.

For the successful implementation of this strategy, the prevailing market trend should be identified first. Sometimes yearly, monthly and weekly trends could be moving in different directions. Such stocks do not offer good perspectives for our purpose. Trading activity should be concentrated on trends that work together. Price breakouts in the direction of the general market movement are useful in searching for new higher highs and higher lows, and in seeking continuation of the momentum in future.

Essential trend trading rules

To be successful here, you should not rely on news but rather on the chart patterns that reflect the underlying fundamentals. As volatility is often present, the determination of the market direction is essential for trading. Also, it is a good idea to search for breakout candidates, should major indices be all bullish or bearish.

The following is a chart example of a breakout that Apple makes on 24 April 2014, which is followed by an impressive rally in its shares:

Changing your mind often on your positions is sure to ruin your trend trading strategy. If you want to make profits, the set and forget principle should be followed. What this means is that once you open a trade, you should have already placed your stop loss order depending on your chart observations. The latter can be moved only if the market has moved in your direction and the support/resistance levels have changed.

The so called golden rule in trading applies: dips should be bought in uptrends and rallies should be sold in downtrends. However, it is essential that you never attempt to pick tops or bottoms. Experienced trend traders prefer to take part in the last 30-35% of the move because it is the most rapid and profits are made pretty quickly. To time their entries they place orders close to support or resistance levels and buy or sell based on the direction of the trend, trying to take advantage of the short-term momentum.

Possible problems in trend trading

One problem can be the false start, when the positive signal is immediately followed by a reversal. Traders’ stop orders are activated and thus their positions closed in the red. The uptrend, however, is renewed soon and traders realize they have been just tricked out of the market, which has shortly afterwards continued to move in their favored direction.

Sometimes dramatic changes in the market conditions occur, in most cases owing to bad news. As a result, financial instruments often make big counter-trend movements, resulting in the so called “shakeout”. The latter means that investors are forced to close their positions on loss since they do not know when the movement will finish. In most cases, that is costly, but it should be done as a precaution as one never knows when the counter trend impulsive movement will finish; sometimes these corrections turn out to be trend reversals as well.

Another problem associated with the trend strategy is the late exit. Investors often do this mistakes striving for bigger profit or because they have been shaken out several times earlier in the trading cycle and believe the same story is being repeated. To counter this difficulty one should always be cautious with rapid corrections or with a breach of mid- or long-term diagonal support/resistance levels.

To illustrate my point on the late exit, I suggest the EUR/USD daily chart. On 9 May 2014, the forex pair gave a clear reversal signal by breaking through its long-term diagonal support. What followed afterwards was a brutal EUR/USD selloff which is far from finished even at this moment.

Taking profits too early is a major mistake that a number of traders make. It is pretty difficult to deal with it because it stems deeply from human psychology. What is of key importance for market players is to try not to follow emotions and be tricked out by perceived “critical” points in the trend. Instead, one should be looking for clear reversal signals in making a decision to close his position.