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A Guide to Trend Trading

Trend trading is a trading strategy that uses technical analysis of an asset’s momentum in a particular direction to target profits.

What does this actually mean?

When the price of an asset is moving in one overall direction, this could be either up or down, that is called a trend. An uptrend is characterised by higher troughs and higher peaks reached by a security’s price whereas downtrends are characterised by lower troughs and lower peaks.

Trend trading is used by many types of traders, including short-term, intermediate-term and long-term.They use price action to see the movement of a security’s price plotted over time in order to determine the trend direction and extrapolate in order to predict where it may shift to soon.

A trend trader will look to buy where they see there is an uptrend. When watching an uptrend, it is ideal to see the price move above recent peak highs but when it does drop, it should stay above previous lows. This pattern shows the overall trajectory as up despite troughs.

Trend trading strategies

  1. Moving average: a simple technical analysis tool that helps to refine price action by filtering out any random short-term price fluctuations and identify a clear trend direction. When a moving average is rising, that indicates that the security is in an uptrend where trend traders choose to buy.
  2. Momentum indicators: the relative strength index (RSI) measures the magnitude of recent price changes which, in turn, gives you the momentum indicator. This identifies when the price is moving upward or downward and how strongly it is doing so. It is how far the indicator is above or below 0 or 100 that indicates how fast the price is moving.
  3. Trendlines: a trend line is a line drawn along troughs in an uptrend or peaks in a downtrend. This shows the possible area where the price may shift back to in the future. Generally, traders choose to buy during an uptrend when the price reaches the trendline, when the price is lower.
  4. Chart Patterns: Traders also look out for patterns, such as flags or triangles, which both suggest a continuation of a current trend.

Does trend trading work?

Trend trading assumes that a security will continue to move in the same direction that it is currently trending. The combination of moving average and other technical analysis aids traders in making an informed decision which helps them make a successful trade.

However, these types of strategies often include a take-profit or stop-loss order in order to limit and investor’s loss at a certain position in a security. These provisions help lock in a profit and avoid mass losses if trend reversal occurs and the price direction changes. As with all trading strategies, profit is not always guaranteed and significant losses are possible, so we recommend reading up as much as possible before you trade.

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