If you want to make money trading stocks and know how to trend trade, there’s a lot to learn about how the market works, what kinds of assets you can invest in, and what strategies you can use to capture the most gains in order to maximize your cash.
Trend trading is one type of investment strategy that you should know about.
- Is a style of trading,
- Attempts to capture gains by analyzing how an asset is moving in a particular direction,
- Usually means entering a long position when a security is trending upward.
In this article, we define trend trading, talk about the history of trend trading and how to spot a trend, and give an overview of some of the trend trading strategies you might use.
What is Trend Trading?
Trend trading, also sometimes called trend following, is a specific style or strategy of trading. In trend trading, traders try to capture gains by analyzing the momentum a security or asset has, and the direction that it’s trending in.
There’s a common Wall Street saying: “the trend is your friend.”
When the price of an asset is moving in one general direction over time, we call that a trend. Trend traders aim to enter into a long position when an asset or security is trending up. They might also opt to enter into a short position when the security is trending lower.
To be a successful trend trader, you must be able to identify trends. This style of trading requires not just the ability to identify a trend, though — trend traders also need to roll with the trends to get their trading accounts up to new heights, rather than fighting the trend. In that sense, trend trading is fairly simple: it essentially means riding existing upward trends to make money.
A Short History of Trend Trading
The idea of trading with a trend, or momentum-based trading, goes back several centuries in history. In fact, that old Wall Street adage we mentioned, “the trend is your friend,” is said to have been coined by David Ricardo, a famous 18th century economist.
Some of the greatest traders in more recent times, from Nicolas Darvas to Bernard Baruch, have understood the power of trading with the prevailing trend in the market, rather than fighting the trend.
Our modern understanding of trend trading, however, really dates back to commodity trading, especially in the early 1980s, when Bill Eckhardt and Richard Dennis, two famous commodities traders, debated whether trading is a skill that everyday, ordinary people can learn. Dennis argued that trading was a skill that could be learned just like anything else, whereas Eckhardt thought that traders had to have a natural, in-born talent for making money on the markets.
The two decided to put their theories to the test with an experiment. The year was 1983. Dennis and Eckhardt put out ads in major business journals to recruit apprentices with little to no trading experience for their study. The apprentices were invited to Chicago for a two-week, immersive training program, and then given a small amount of money to begin investing with. Over the next four years, this inexperienced group managed to pick up more than 80% in compounded gains: not bad for beginners! The experiment showed that Dennis was right: nearly anyone could be trained to win on the markets, with the right teachers and by learning the right set of skills.
Today, trend trading is a strategy used by many traders, both newbies and those with experience on the markets.
What is a Trend?
In short, a trend is the overall direction that the market is heading in. In general, the stock market can trend in one of three different directions: up, down, and sideways.
An upwards or downwards trend is quite simply that: when the market is steadily gaining or losing value. To use the typical terminology, a bullish trend is an upwards trend, while a bearish trend is a downwards trend.
A sideways market, or sideways drift, occurs when the price of a security stays fairly steady without trending up or down overall. In other words, sideways trends happen when the market oscillates generally over a horizontal range, but without becoming either bullish or bearish.
How Does Trend Trading Work?
Trend traders look for market trends: that is, they see whether they can impose a trend line to reveal the direction that the market is heading in in the future. Generally speaking, with trend trading, if the market is trending upward then you buy stock, whereas if it’s trending downward, you sell.
Beyond this simple metric, there are a number of different trend trading strategies to try out. Each strategy relies on different metrics and indicators in order to signal when it’s time to buy or sell shares.
The simplest trend trading method is trend line analysis. With this method, traders first determine whether they’re bullish or bearish on the market. If they think the market is trending up, traders identify areas of support to use as entry points or to place stop losses. If they think the market is trending down, then the trader will identify areas of resistance as possible entry points or placement for stop losses.
Moving averages involves monitoring not just general trends in the markets, but also trends in the short-term moving average. For example, when the short-term moving average crosses a certain threshold vis-a-vis a longer-term moving average, the trader will take a long position. Most trend traders combine moving average strategies with other forms of technical analysis to identify market signals.
A momentum indicators strategy looks to particular metrics and stats to determine a market trend. For example, many trend traders will look to the Relative Strength Index, or RSI. The RSI is a momentum indicator that gives you a measurement of recent price changes. For example, a trader might decide that he or she will exit when RSI rises above 70 or 80 and then drops back down to a pre-selected level.
The best trend traders use a combination of strategies and metrics to analyze trends and decide whether and when to buy and sell shares or other securities.
How Can I Start Trend Trading?
If you like the idea of analyzing market trends to buy and sell stocks and make money doing it, trend trading is a good way to get your feet wet. Trend trading is relatively less risky and complicated than day trading, so it’s great for those who are relatively new to trading, or want to pilot a different trading strategy or approach.
To get started with trend trading, you’ll first need to generate a trading strategy. Decide on your investment goals and the level of risk you’re willing to take on. From there, determine which indicators you’ll use to analyze trends, as well as how much money you want to invest in each position and how many shares you want to be holding at a given time. Check out our visual training tools to learn more about how build your own trading strategy.
You’ll also need a trading platform once you’ve decided on a strategy. Research the different platforms and the pros and cons of each one. E*TRADE, TD Ameritrade, and Fidelity Investments are all commonly used online platforms for trading stocks.
Pros and Cons of Trend Trading
Like any of the other trading strategies, there are pros and cons to trend trading. On the upside, trend trading doesn’t require a ton of your time, and requires less training than other styles of trading, such as day trading. For these reasons, it’s a great way for beginners to learn more about the market.
Trend trading is also relatively less risky than other trading approaches. It allows you to focus on achieving medium- and long-term success. In addition, since you’re making fewer numbers of trades overall, the day-to-day risk is somewhat lessened as compared to day trading, where you’d be making multiple trades per day.
Plus, we think trend trading is just plain fun! It lets you get your hands dirty doing research, learning about companies, and trying out different stocks. If you’re a data nerd (like we are), you’ll love trend trading.
Trend trading does have some drawbacks that you should be aware of before getting started. Most of the downsides of trend trading relate to timing. If you’re impatient and want to make a quick buck without putting in the work, trend trading won’t work as well for you. People who don’t want to make the commitment to doing their research and learning the trade won’t prosper with trend trading, in our experience. That being said, there are plenty of upsides to explore!
RagingBull is the premier destination for both new and veteran traders who want to learn more about how to make money with trading. Our team of experts are active traders themselves, and they’re ready and willing to teach you everything you need to know about trading to win. For a limited time, you can check out a free copy of our options handbook. You can also schedule a free training session with one of our expert trainers on your own schedule to learn more and start investing to win today.