What is Trend Trading
Trend trading is a trading strategy that attempts to capture gains through the analysis of a security's momentum in a particular direction. Trend traders enter into a long position when a security is trending upward (e.g. successively higher highs) and/or enter a short position when a security is trending lower (e.g. successively lower highs).
BREAKING DOWN Trend Trading
Trend trading strategies assume that a security will continue to move along its current trend and often contain a take-profit or stop-loss provision if there are any signs of a reversal. It can be used by short-, intermediate- or long-term traders. Regardless of their chosen time frame, traders will remain in their position until they believe the trend has reversed, although reversals may occur at different times for each time frame.
Trend trading was popularized in the 1980s when Richard Dennis and Bill Eckhardt recruited and taught a small group of traders, known as the Turtle Traders, a trend trading strategy that netted them more than $100 million in profit. Galen Burghardt later showed that there was a 'very high' correlation between broad market indexes and trend-following commodity trading advisors, suggesting that trend trading was the predominant strategy used by technical traders in the commodity (and potentially other) markets.
Trend Trading Strategies
There are many different trend trading strategies using a variety of indicators:
- Moving Averages - These strategies involve entering into long positions when a short-term moving average crosses over above a long-term moving average, and entering short positions when a short-term moving average crosses below a long-term moving average.
- Momentum Indicators - These strategies involve entering into long positions when a security is trending with strong momentum and exiting long positions when a security loses momentum. Often times, the relative strength index (RSI) is used in these strategies.
- Trendlines & Chart Patterns - These strategies involve entering long positions when a security is trending higher and placing a stop-loss below key trendline support levels. If the stock starts to reverse, the position is exited for a profit.
Often times, traders use a combination of these strategies when looking for trend trading opportunities. A trader might look for a breakout from trendline resistance levels to indicate the start of a new trend, but only enter into a trade if a short-term moving average is trading above a long-term moving average. They may then use momentum indicators and trendlines to identify the best take-profit or stop-loss points.
It's important to use trend trading strategies in conjunction with risk management techniques to maximize risk-adjusted returns.