Why in the world would you want to find trends to trade? Contrary to the popular belief that you should embrace the buy-and-hold strategy, understanding how to trade the stock market trends and cycles is crucial to every investor’s success and can lead to some pretty sizeable profits.
By recognizing the changes in trends as they are happening, you can protect and preserve your capital while reaping profits in any market environment. And if you’re looking to become an active trader, trend trading provides a more realistic chance of long-term success.
Today, this blog seeks to unpack every important detail you need to know about finding trends to trade.
What is Trend Trading
Otherwise known as trend following, trend trading simply means taking trades in the direction of the market momentum. In essence, you’re simply trying to capture gains by analyzing an asset’s momentum in a specific direction. Pretty simple right? Unfortunately, not so much.
Multiple factors determine whether your trade in the current market direction will succeed or not. The important aspect isn’t whether you’re taking a trade in the current market direction but whether the market will continue moving in your anticipated direction after you’ve placed your order.
Trend following is used by short, intermediate, and long-term traders who rely on technical indicators to predict the direction an asset will move.
How to Identify a Trend
As easy and profitable as trend following can be, profitable trading needs more than simply watching which way the market is moving — you need to know where to start. Remember, even if the market is moving in a specific direction now, there’s no guarantee that it will continue in the same direction after you enter a position. However, you can significantly improve returns by learning and identifying some common trends.
Generally, there are two main types of trends: uptrends and downtrends. An uptrend describes when the price of a stock is getting higher or moving upward — the chart’s peaks and troughs gaining new maximums as the trend continues.
An uptrend gives you the opportunity to buy low, sell high, and potentially continue to profit until the trend starts reversing. Most traders exit their positions when the stock peaks and troughs are no longer breaking new highs.
A downtrend is simply the opposite of an uptrend — it’s when the price of a stock is getting lower or moving downward. A downtrend has the same characteristics as an uptrend, but in the opposite direction. The peaks and troughs in the movement chart continue to drop as the trend continues. Downtrends won’t be profitable if you enter a long position, but they can be every short seller’s profiting punch.
How to Identify Market Trends to Trade
Short, intermediate, and long-term trends are the three popular trend types you’ll come across every day. However, learning how to identify a trend should be your first order of business when learning the art of trend following.
Primary Trends
According to historic observations, primary trends can last from one to three years. However, this trend can still go beyond this timeframe. Most traders consider the primary trend as the main trend, unless there’s a clear sign of reversal.
A primary trend may take the form of constant increase in stock prices for the given timeframe. In this case, subsequent peaks would be constantly higher than the previous ones. Similarly, a constant fall in stock prices could also mark a primary trend.
Secular Trends
A secular trend is longer than a primary trend, and you can expect it to last for one to three decades. A secular trend holds many primary trends, which makes it incredibly easy to recognize due to its timeframe.
Intermediate Trends
Intermediate trends are typically usually within primary trends, and they keep analysts constantly looking for answers for why a market suddenly makes a turn in the opposite direction to that of the previous day or week. Intermediate trends are often signified by sudden directional turnarounds and rallies, often as a result of a political or economic action. An intermediate trend can last anywhere between two to eight weeks.
Indicators to Find Trends to Trade
Indicators are at the center of trend trading, so you should first identify and understand what indicators to use. Moreover, although there’s no guarantee that the indicators are 100% accurate at picking out every single trend, you can still use them to filter out markets that are just trending weakly or not trending altogether. Common indicators to finding trends include:
Moving Average
The moving average is a technical indicator that shows the average value of a security over a given period. The amount of time the moving average covers varies considerably depending on the trader and the strategy used. Some traders may use the moving average from a few hours or days while others will follow it for over 100 days. Regardless of the period, the moving average data can be used to identify trends.
It’s difficult to see trends when the prices of securities are volatile. Luckily, the moving average creates a smooth line of the price data, minimizing the impact of price fluctuations that just occur randomly. An uptrend can be identified by a rising moving average while a falling moving average signifies a downtrend.
Moving Average Convergence Divergence (MACD)
The MACD is a technical indicator designed to show the relationship between two sets of moving averages. You can calculate the MACD line by subtracting a 26-period EMA (Exponential Moving Average) from a 12-period EMA. The EMA gives greater weight to more recent price data.
A sudden increase in the MACD indicates that a stock has been overbought and that it could fall back to normal. The inverse is also true.
Relative Strength Index
The Relative Strength Index (RSI) is supposed to help you predict whether an asset is currently oversold or overbought. This index is conveyed as a number between 0 and 100, measuring the magnitude of recent changes in the security price. A security is considered overbought if the RSI reaches or exceeds 70, an indication of a strong uptrend.
A security is deemed oversold when the RSI drops below 30, a strong indication of a downtrend. Traders will want to take a long position in a security when the RSI moves above 30 in anticipation that the market is appreciating.
Tips to Identify Trends
Identifying trends actually goes beyond just the technical indicators. Here are some other ways you can identify trends to trade:
- News catalysts. News catalysts are events or revelations that may lead to a dramatic change in the price of a stock or the entire stock market. A news catalyst can be anything you interpret as bad or good news and may include things like:
- A lawsuit
- Mergers or acquisitions
- New government legislation
- Earnings reports falling short or exceeding expectations
The effect of a news catalyst on the market might not be immediate, but it can excite investors, and therefore drive the market down or up. Different investors place different value levels to news catalysts. Momentum investors make most of their trading decisions based on news catalysts while value investors will focus on the market fundamentals.
- Stock screeners. Stock screeners let you filter stocks by industry, valuation, sector, margins, average volume, balance sheet, and income statement. You can also separate the small, mid, and large-cap stocks. Just set your own metrics and a stock screener will provide the stocks that match your criteria.
You can use stock screeners to identify stocks that are expected to perform well in the long term as well as any potential setups for short-term positions. You can effectively weed out hundreds of stocks to remain with what matters.
Final Thoughts
Trend trading simply means you’re letting the momentum in a stock’s price influence your buying and selling decisions. Trend following can be a profit-reaper since it eliminates emotions to put data and technical analysis as the basis of your decision making, which isn’t a bad thing after all.
Disclaimer: Benzinga is a news organization and does not provide financial advice and does not issue stock recommendations or offers to buy stock or sell any security. Benzinga Pro is for informational purposes and should not be viewed as recommendations. Benzinga Pro will never tell you whether to buy or sell a stock. It will only inform your trading decisions. You can find our full disclaimer located here.