What Is Trend Following? | Trading the Trend

Trend TraderWhat Is Trend Following? | Trading the Trend What is trend following? Many of us follow fashion trends. In some places, coloring your dog’s fur may be trendy. In other places and times, we follow popular hairstyles. How does one follow a trend? To do this, you see a guy say, wearing a mullet haircut. You take notice, saying to yourself, I like how he combines the short front with the long back. You like it, but not enough to grow one yourself. Not just yet. A few days later, you notice some of the downtown guys donning the mullet. In a few weeks, you see your favorite pop star running his fingers through his mullet as he speaks to a beautiful reporter about his new video.  Bang! It’s time for you to get your mullet my friend! Your mullet is a hit for a strong 3 months of the summer. As fall rolls through, your favorite pop star has trimmed his mullet. You start to notice less and less people in the mall sporting mullets as well. You don’t want to be the last guy rocking a mullet, do you? Of course not. The trend is losing steam, so you get out before you become one of the last guys asking your barber to shape up your mullet. Trend TraderA trend following trader employs similar tactics when deciding on making purchases in the financial markets. Lets replace the mullet in the previous example with an imaginary stock. Mullet Inc. will be our imaginary company. The company trades under the MU\ ticker.  Mullet has been trading at around $20.00 for the past 6 months. Over the past 3 weeks it has been trading at $25.00. This would get your attention, since the stock seems to have broken out of its range. You continue to watch this and the stock has now reached $27.00. This is the highest mullet has ever traded for. At this point you decide to place an order for 10 shares. Your order was filled at $28.00, so you’re now holding $280.00 worth of MU\. The main idea of trend following is to buy into a stock that has already shown upward or downward momentum. You are not trying to predict where the bottom or top of a trend is. You are just getting into the action once you see the price is moving, and exiting the trade when the trend reverses, or goes against your position, as seen here. trend following chart guide There are various ways to set your stops when following a trend. Some systems base their stops on a percentage of what they bought, some base it on a multiple of the average trading range (ATR) of the stock at the time it was purchased. To simplify this example I’ll use an initial stop loss of 1% and initiate a 25% rolling stop once the stock goes 25% higher than it’s purchase price.  This means that if the stock price falls from $28.00 to $27.72 you sell all 10. If the price rises beyond $37.33 I start to move the stop up. If the stock reaches $40.00, you would move the stop price to $30.00, putting you in the money. A wide trailing stop like this allows for volatility, while protecting your trading capital by keeping you losses fairly small. To some, this wide stop causes you to give back too much of the profit. The stops are generally wide in trend following because the trend follower is attempting to capture pieces of large movements. Wider stops allow you to stay in trades longer, but “give back” the profits at the extreme ends of the trends, while tighter stops capture more of these tail ends, but cause you to get stopped out faster because of volatility. Ultimately, the choice is yours. Back to our imaginary MU\ stock.  The price has moved up to 49.00 in the following 2 months. You’ve moved the stop to $36.75. Two days later, the price makes a U-Turn and starts to fall. $47.10, $43.39, $40.75, $38.01, down to $36.10. You see a little bit of slippage so your stop is executed at $36.74.  you’ve made $8.74 per share giving you a profit of $77.40 ($87.40 – $10.00 service charges). This example is fairly ideal. Chances are you will have more losing trades than winning ones. The idea of trend following is that the winning trades will be generally follow lasting trends. Those trends could gain enough to overcompensate for the numerous small losses. Trend following allows traders to capture trends that have already began. A trend follower doesn’t need to know get in at the beginning of a trend to profit. If proper risk management techniques are utilized, trend following can be a useful trading tool. The success is based on the indicators used to point out trends as well as the traders ability to follow the system. Trend following is also prone to drawdown periods, which can make it psychologically difficult to adhere to at times. As with any method, there are always inherent risks.  In a long drawdown period, it can be difficult to know if you’re experiencing a long drawdown, or if you’re trading an ideology that isn’t working. Trend following is one ideology for trading markets. Many ideologies can work with trading. The important thing is to find one that fits your beliefs about the financial markets. I think it is always important to decide on how much you are willing to lose on a trade before taking it. Losing is ok as long as the losses are small and your profits are allowed long enough to keep you in the money. Get in when things are looking good, and get out when they’re going against you. Don’t hold on, hoping that the trend will come back. Trend Trader Posted By: Tahric Finn

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2 Comments

  1. I received a link about your post from a coworker. She is right about you. Your blog is very excellent.

  2. You could ask a lot of questions. I would need to know more information about the seminar, before I could help you out.
    Chad Grant
    Trendmovements.com

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