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Article / 15 January 2014 at 9:44 GMT

Trend following explained: How to stay in a trending asset

Trader / TheSteadyTrader.com
United States

One of the most psychologically difficult but most rewarding trading strategies is that little something called trend following. This strategy is often applied by macro fund managers, trend follower funds and an array of other players. To some extent, most traders and investors are trend followers, the difference lies in their approach to analysing the market.

By definition, in the trend following strategy, traders and investors simply stay the trend in the underlying market until it ends. It's a straightforward concept, however it is also one that novice traders often underestimate by miles in terms of the degree of skill needed to successfully execute the strategy. Novice traders look at a trend, see a low point and a high point, and think to themselves, how hard can it be to simply buy when the trend goes up and sell when it changes? Ah, there's the rub, and let me fill you in on a secret: picking absolute lows and highs in trading and investing on a consistent basis is impossible. So, if picking extremes on a chart is impossible, how does a successful trend follower execute his/her strategy? 

The trick lies in having a set of rules and technical tools that if and when triggered, give the trader the nod that his entry point, stop loss, or profit target has been hit. The second and more difficult part is training ones brain to actually take the trade when the signal has arrived, and leave second guessing, doubt, fear and greed checked at the door — each and every time. Consistency is the key to success here. The more consistent a trader is in sticking to his/her rules, the less taxing the trend following strategy is on the mind.  

Here is my check list for trend following:

• Golden Rule: Don’t chase, patience is rewarded!
• Buy/Sell: Pullbacks to moving averages and/or trend lines or breakouts
• Buy/Sell: Breakouts above moving averages and trend lines
• Buying/selling after confirmation increases odds of success
• Buying/selling at pullbacks greatly limits losses and maximises profitability
• Use momentum oscillators for confirmation of support/resistance at moving averages and trend lines
• Use candlesticks for confirmation of support/resistance zones
• Use confluence zones — i.e. the coming together of multiple indicators, to add to trend following positions
 • It’s ok to get stopped out — that's the cost of doing business
 
A trend is broken or weakening when...
 
• A major trend line or moving average snaps
• Long candlesticks (engulfing, hammer, shooting star…) start to appear on the charts
• Momentum oscillator begins to show divergence from price action
 
All of this might sound overly simplistic, but these are the broad rules that I have applied to successfully stay on the side of major trends over the years.
 
An actual trend following example
One stock that I have been riding higher on and off for more than eighteen months is Google (GOOG:xnas). When a moving average or trend line breaks, then the following support zone below gets targeted. Back in October 2013 for example, when Google stock broke below its 50 and 100-day moving averages, the next support became the trend line, which ended up holding like a champ, making me go back to a long position in the stock. As the stock pushed back above the moving averages, I added. Currently, the stock through this lens is overbought as it trades above the upper trend line.
 
Google Inc Daily Chart
Source: Saxo Bank
 
 
(xcma)

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