Trading trends or trend following is a systematic method of profiting from market movement. Investing in trend following involves buying when an asset’s price rises and selling when it falls. 

A trend-following approach is best suited to those who prefer to trade systematically, diversified manner.

The goals of this post are to review the trend following theory and examine some of the most successful traders. They utilize trend following and explore some of the most popular indicators and strategies to identify trends.

What is trend trading?

By analyzing an asset’s momentum in a particular direction, traders attempt to capture gains through trend trading. Trends occur when prices move in a specific order, such as upward or downward.

The trend trader enters a long position when security shows a positive trend. In an uptrend, swing lows are higher, and swing highs are more elevated. In the same vein, trend traders may choose to enter a short position if an asset is trending downward. There are fewer swing lows and fewer swing highs during a downtrend.

Trend following indicators

You’ll first need to determine which indicators and strategies to use if trend following appeals to you. Indicators are tools, and strategies are a way to combine indicators and position rules to achieve the desired result.

Moving averages

Indicators based on moving averages are some of the easiest and most popular. Moving averages are calculated by calculating a security’s average price over time. 

Depending on the trader and the strategy, the moving average can cover a range of time. Moving averages of the past 50, 100, or even 200 days might be used by trend followers, while traders using more short-term strategies might use standards from days, hours, or even minutes.

Moving Average Convergence Divergence (MACD)

Two moving averages are used in the Moving Average Convergence Divergence (MACD) indicator to determine how their relationship works.

MACD uses crossovers similarly to some of the strategies that use moving averages. MACD is considered bullish when it crosses zero and moves upward. A MACD crossing below zero signifies a bearish signal.

Furthermore, this is considered bullish if the MACD crosses above the signal line. The MACD cross below the signal line indicates a bearish trend.

Relative Strength Index (RSI)

The Relative Strength Index (RSI) also oscillates, like Moving Average Convergence Divergence. RSI indicates whether security has reached its overbought or oversold level. In RSI, a number between 0 and 100 indicates how rapidly a security’s price has changed recently.

Indicators such as the RSI are popular for analyzing shorter-term trends – especially when combined with volume and multiple timeframes.

Chart patterns

Using chart patterns to determine entry and exit points is not usually considered a trend-following indicator. In chart analysis, we’re not just looking at a price; we’re looking at the psychology of buying and selling pressures. Profitable technical traders take advantage of human psychology.

Bottom Line

Most trend-following indicators are ‘lagging,’ which generates signals after the trend has already started or reversed. Lagging trend-following indicators are the most commonly used moving averages. 

Using multiple calculations and comparing momentum in different time frames, these indicators can also be characterized as ‘leading’ indicators, which predict price action before it begins. 

Traditional traders make behavioral mistakes that lead to their loss of profitability when using systematic trading strategies. Using systematic rules and principles improved the trading profitability and Sharpe ratio.

Ryann Ziemann