By Rick Ratchford
Trend trading is a trading approach that offers the potential to reap greater profits by capitalizing on large market moves. There are two main concerns dealing with trend trading; either the market is trending upwards (bull trend) or trending downwards (bear trend). For the trend trader to profit, it is important to correctly identify the trend before a trade is placed.
When it comes to trend trading, once the trade has been placed, the trend trader will usually stay in the trade until such time that it appears the overall trend has changed.
Trends occur at different time frames and can be seen on various time-frame charts. A trend trader, being more a long-term trader where trades usually last a few weeks or more, will likely define a trend from analyzing a daily or greater time-frame chart. Minute charts may be used for fine-tuning entry, they certainly would not be used for determining the trend.
The time-frame of the charts used is very important to the trend trader. If the trend is being defined on a weekly chart, it is the weekly chart that should be used to determine when the trend has ended as well. By doing this, the trader is not exiting a weekly or greater trend just because the trend has changed on the lower time-frame daily chart.
There are many counter-trend moves that occur within a complete trend move. These are usually seen on the lower time-frame charts in respects the time-frame used to define the trend. For example, if a weekly chart is used to define a bull trend in the SP500 market, there will be moves against this bull trend that will be easy to see on a daily time-frame chart. The trend trader would normally stay in a trade even when the market is moving against the position, as it is expected to recover soon if the trend is still intact.
Trend traders often use indicators such as the moving averages to determine when to enter and when to exit. For example, a trend trader may buy when the 50-day moving average is greater than the 200-day moving average, and sell when the 50-day moves below.
For most traders, staying in a trade when the market is making a move against the trend direction is difficult to do. You really have to stick to your guns and avoid reacting to the market as it moves to erode your accumulated profits if you want to be successful as a strict trend trader.
The other type of trader to consider is the Swing Trader. Swing traders usually trade off the daily time-frame or lower (minute charts). Swing trading is all about following the market’s most likely current direction. For new traders, swing trading can be a more effective approach due to the shorter period of holding a trade and usually less exposed in risk capital. Swing trading is considered by many to be an easier and less stressful way to enter the markets.
The swing trader will usually go long when the short-term market is confirming a swing bottom and looking to move up, and going short when the market is confirming a swing top and looking to move down. Thus while the trend trader may be holding a long based on a bullish weekly trend, the swing trader could be either long or short during this same period because of the direction the market is currently moving in the lower time-frame.
With trend trading, the cons are clear. You must allow for possible large moves against your position when the trend is in a counter-trend phase. With swing trading, the cons are also clear. While the overall market is trending in one direction, the swing trader will at times be trading against this trend which is often wrought with greater risk than trading with the overall trend.
Therefore, when considering the negative aspects of both trend trading and swing trading, why not simply use the best of both?
In order to do that, it is important to determine first the overall trend direction much like the trend trader would do. So if you do so based on moving averages as in the earlier mentioned example, then all your trades should only be in that direction. Therefore, if the trend happens to be bullish, take long trades off swing bottoms and look to exit off swing tops rather than shorting them.
Several years ago I wrote a training document called the Guidelines that does just as I have described in this article. We first identify the current weekly trend based on the most recent formation of a weekly swing top or bottom in relation to previous weekly swings. Once the direction is determined, we look to only enter the market going ‘with the trend’.
While swing traders will usually apply two or more indicators in an attempt to determine when the short-term swing is occuring, I like to use mathematically calculated ‘turn dates’ that provide the date as to when these swings are most likely to occur. Once this is known, we simply allow the market to confirm the swing which signals the trade entry.
Note these words found on page 11 of the book “How to Make Profits Trading Commodities” by W. D. Gann.
“THE BEST WAY TO TRADE: The most money is made by swing trading, or in long pull trades, that is following a definite trend as long as the trend is up or down…Wait for definite indications that it is going higher or lower, before you take a position for a long pull trade…get out when you get a definite indication that the market has reached a turning point and that the trend is changing.”
So in order to get the most of your trading and to keep your risk as low as possible, look to determine the overall trend first and then only trade off swings in that direction.
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