What is trend trading?
Trend trading also known as trend following is a trading strategy which assumes that a security is likely to continue to move in the same direction as it is currently trending. The concept is based on predictability by analyzing the latest price fluctuations and historical trends, a trader can predict the future price patterns to try to capture gains through taking positions along a cycle of expected price movements.
This strategy heavily relies on using technical analysis and its components, such as technical indicators and oscillators, chart patterns and trendlines to identify the direction of market momentum. Simply put, trend trading revolves around a trader making purchasing and selling decisions based on trends.
How does trend trading work?
Trend trading is simply an approach in which a trader identifies that a trend is in place, enters the market in the direction of the trend and holds the position until the trend reverses. It is done by finding low-risk entry points and using technical indicators throughout the trend to identify potential reversals.
Usually, trend traders pay little to no attention to retracements, which are temporary moves against the prevailing trend. However, it is crucial to confirm it is just a temporary move rather than a complete trend reversal, which indicates a need to close a trade.
Generally speaking, there are three primary types of trend: uptrends, sideways trends and downtrends. An uptrend is characterized by a series of higher swing lows and higher swing highs, while a downtrend is defined by lower swing lows and lower swing highs. Sideways trends occur once a market price is neither reaching lower price points nor higher ones.
Trend traders often enter into a long position when a security is in an uptrend and tend to choose to enter a short position when an asset is in a downtrend.
Trend trading is a mid to long-term strategy. However, it can theoretically cover any timeframe, depending on how long the trend continues. For that reason, the strategy is usually adopted by traders who prefer a swing trading or position trading style, as those tend to hold a trade throughout an entire trend.
As trends may occur in any financial instrument, this style of trading works in most asset classes, including stocks, bonds, commodities and forex markets.