What is Trend Trading?

In the financial market, no profits are the same. The reason generally includes mentality, trading style, and the chosen asset by investors. As hundreds of trading options are available and the ultimate goal is to earn the highest amount of profits, investors try their hands on all trading styles until they find the one that works for them. Derivatives trading, bonds trading, and the like can be complex for a beginner-level investor. However, some techniques are simple yet effective enough to yield hefty returns irrespective of you are a professional investor or a beginner.

One such widely used trading technique is trend trading. Investors look toward the market direction before executing an order and believe that the trend or the market’s current direction will continue for some time. With this belief, they enter the market at the right time and realize profits based on the price difference triggered by the market trend.

If you are looking to start investing, trend trading can be a great first technique to make quick and good profits.

Trend Trading

The one principle that any financial market follows is Trends. A Trend is the direction of the market; it can be bearish (falling prices) or bullish (rising prices). Past market patterns reveal that asset prices follow a trend where if the market is bullish, the prices keep on rising shortly.

Thus, investors looking to profit place an order in such conditions hoping that the market will follow the current trend. Trend Trading is the trading style through which investors attempt to realize profits based on the current market trend and the asset’s momentum. Trend Trading is undertaken by investors based on various technical indicators to help them identify the current market trend.

Features of Trend Trading

Here are some common features of Trend Trading:

  • Trend Trading is designed to realize profits when the market is bullish or showing bearish signs.
  • Trend Trading bases its operations on higher swing highs, higher swing lows, lower swing highs, and lower swing lows.
  • Investors look towards past market patterns and various other indicators such as trendlines, moving averages, etc., to identify the current market trend.
  • Trend Trading works on the principle that trend reversal takes time, and the current trend is generally followed by the market for some months.

How does Trend Trading work?

Investors leverage trend trading by operating on the take-profit or stop-loss basis to avoid huge losses or otherwise take-home profits. An investor undertaking trend trading uses two types of orders to trade:

Long Position: This is when investors think that the market will scale to new highs, and they buy assets, simply waiting for them to reach a higher price.

Short Position: This is when the investors think that the market will go down further and opt for a short position to benefit from the future lower prices of the assets.

For example, suppose the current price of a stock is Rs 500, and it has risen from Rs 420 to the current price in one week. While analyzing other stocks and technical indicators, investors believe the market trend to be bullish (described below) and expect the price to go above Rs 650 in the next month. This makes up for the basis of trend trading, where the investors buy a large number of stocks at the current Rs 500 (long position) and wait for the stock to reach Rs 650. Once the stock reaches the target price, they sell the stock and make profits based on the price difference and the number of stocks purchased.

Identifying Trends: Types of Trend Trading

There are three types of trend trading:

Uptrend (Bullish): When a majority of the assets are increasing in their price, along with the market in its value, it is called an Uptrend. In such a case, the investor enters into a long position. For example, if a company’s share price increases by 100 points, then decline by 30 points, then rises by 130 points, and again falls by 40 points, the stock is referred to as being in an Uptrend as it is showing higher highs and higher lows.

Downtrend: When a majority of the assets are decreasing in their price, along with the market in its value, it is called a Downtrend. In such a case, the investor enters into a short position. For example, if a company’s share price decreases by 200 points, then increase by 100 points, then falls by 330 points, and again rises by 70 points, the stock is referred to be in a downtrend as it is showing lower highs and lower lows.

Sideways Trend: Sideways trend is when the market is neither falling nor rising in its value over a specific period. Most trend traders avoid placing an order in this kind of market. However, range traders or scalpers utilize this trend to benefit from the extremely short-term price movement.

Strategies of Trend Trading

The following three strategies are used during Trend Trading by investors to identify a market trend:

Daily Moving Average (DMA)

The DMA makes it easy for a trader to identify trading opportunities within the market’s overall direction. Any technical trader can effectively use moving averages to identify the trend and the critical levels to buy or sell the stock.

Daily Moving Average is one of the basic pillars of technical chart patterns for trading. The moving average is a rolling days’ average where the data points keep skipping and calculating. Popular moving averages are the 50-DMA, 100-DMA, and 200-DMA. Moving averages are very useful in identifying a stock’s support and resistance levels, which enables investors to fine-tune their buy or sell decisions. Averages can be simple (SMA) or exponential (EMA).

Relative Strength Index

When it comes to overbought and oversold stocks, the big question is not “whether” but “when”. The timing of your entry and exit is the focal point. The RSI answers this question.

The Relative Strength Index (RSI) is also called an oscillator. An oscillator helps the trader to identify whether the particular stock or contract is overbought or oversold. The RSI, being an oscillator, is plotted on a scale of 0-100. An RSI level of 100 indicates that the stock is extremely overbought, while a level of 0 indicates that the stock is extremely oversold.

Moving Average Convergence Divergence (MACD)

MACD is referred to as the king of technical indicators since it encompasses moving averages and oscillators. MACD identifies the overbought and oversold zones in the chart and identifies the right entry and exit levels. It is very flexible and can be used in range-bound and trending markets.

Stochastics

The stochastic line, as it is popularly called, is an extension of the RSI indicator. The only difference here is that the stochastic also looks for a double indicator. Hence, for a trader looking to reduce risk, the stochastic becomes a more reliable indicator.

The RSI does not look for double confirmation before identifying overbought and oversold zones. In contrast, the stochastic gets a double confirmation that the overbought and oversold zones are genuine and not a trap. The stochastic identifies the %K&%D line and uses crossover to identify greater conviction and precision for oversold levels.

Conclusion

The market always follows any of three trends: Uptrend, Downtrend, and Sideways. As investors have proven strategies to identify these trends and execute orders, trend trading is one of the safest and most profitable trading techniques. If you are looking to make profits through trend trading, you will need to open a Demat and trading account. To open the two accounts for free, you can follow the simple steps laid out by IIFL to open your account in less than 24 hours. You can visit IIFL’s website or download the IIFL Markets app from the app store. Once you have, click on the ‘Open Demat Account’ options, fill in the required details, submit the required documents, and IIFL will open your accounts.

Frequently Asked Questions Expand All

Among hundreds of trading strategies, trend trading is considered the most profitable trading strategy. It is because of the notion that the market tends to follow the current trend for a period of time, making it safe for investors to place long or short orders and realise profits from the price difference.

Trend trading is considered the most profitable trading strategy. It does not include complex trading methods but easy-to-analyse technical indicators to identify the current market trend. Once identified, investors can make hefty profits by placing market orders.

Trend trading rules are the same as any other trading technique and require the investor to have a Demat and trading account. The Demat account is used to virtually hold the bought securities, while the trading account is used to complete the included transactions.