MT5_6. Trend Trading

Lesson 5: Trend Trading

What is 'Trend Trading'?
Trend trading is a trading strategy that attempts to capture gains through the analysis
of a security's momentum in a particular direction. Trend traders enter into a long
position when a security is trending upward and/or enter a short position when a
security is trending lower.

Trend trading strategies assume that a security will continue to move along its
current trend and often contain a take-profit or stop-loss provision if there are any
signs of a reversal. It can be used by short-, intermediate- or long-term traders.
Regardless of their chosen time frame, traders will remain in their position until they
believe the trend has reversed, although reversals may occur at different times for
each time frame.

There are many different trend trading strategies using a variety of indicators:

Moving Averages - These strategies involve entering into long positions when a
short-term moving average crossover above a long-term moving average and short
positions when a short-term moving average crosses below a long-term moving
average.
Next we have Momentum Indicators - These strategies involve entering into long
positions when a security is trending with strong momentum and exiting long
positions when a security loses momentum. Often times, the relative strength index
(RSI) is used in these strategies.
Next we have Trend Lines & Chart Patterns - These strategies involve entering long
positions when a security is trending higher and placing a stop-loss below key trend
line support levels. If the stock starts to reverse, the position is exited for a profit.
It is often that traders use a combination of these strategies when looking for trend
trading opportunities. A trader might look for a breakout from trend line resistance
levels to indicate the start of a new trend, but only enter into a trade if a short-term
moving average is trading above a long-term moving average. They may then use
momentum indicators and trend lines to identify the best take-profit or stop-loss
points.

It's important to use trend trading strategies in conjunction with risk management
techniques to maximize risk-adjusted returns.

As a trader, you have probably heard the old adage that it is best to "trade with the
trend." The trend, say all the pundits, is your friend. This is sage advice as long as
you know and can accept that the trend can end. And then the trend is not your
friend.

So how can we determine the direction of the trend? Usually, when we are analyzing
long-term investments, the long-term time frame dominates the shorter time frames.
However, for intraday purposes, the shorter time frame could be of greater value.

Trades can be divided into three classes of trading styles or segments: the intra-day,
the swing and the position trade.
Large commercial traders, such as those companies setting up production in a
foreign country, might be interested in the fate of the currency over a long period of
such as months or years. But for speculators, a weekly chart can be accepted as the
"long term."
With a weekly chart as the initial reference, we can then go about determining the
long-term trend for a speculative trader. To do this we will resort to two very useful
tools that will help us determine the trend. These two tools are the simple moving
average and the exponential moving average.

In the this weekly chart, you can see that for the period of May, 2006 until July, 2008
the blue 20 interval period exponential moving average is above the red 55 simple
moving average and both are sloping upward. This indicates the trend is showing a
rise of the euro and therefore a weakening dollar.
In August, 2008, the short-term moving average (blue) on the chart turned down,
indicating a potential change in trend although the long-term average (red) had not
yet done so.
In October, the 20-day moving average crossed over the 55-day moving average.
Both were then sloping downward. At this point the trend has changed to the
downside and short positions against the euro would be successful.
The goal here is to determine the trend direction, not when to enter or exit a trade. Of
course this is not to say that there were no trading opportunities in the shorter time
frames such as the daily and hourly charts. But for those traders who want to trade
with the trend, rather than trading the correction, one could wait for the trend to
resume and again trade in the direction of the trend.

By setting up a short-term exponential moving average and a longer term simple
moving average, on a weekly and a daily chart, it is possible to gauge the direction of
the trend. Knowing the trend does help in taking positions but bear in mind that the
markets move in waves. These waves are called impulse waves when in the
direction of the trend and corrective waves when contrary to the trend.

By counting the waves or pivots in each wave, one can attempt to anticipate whether
a trading opportunity will be against the trend or with the trend. According to the Elliot
wave theory, an impulse wave usually consists of five swings and a corrective wave
usually consists of 3 swings. A full wave move would consist of five swings with two
of the swings being counter trend.

This image gives an example of an Elliot wave. Because Elliot wave theory can be
very subjective, it is recommended to use a pivot count to help determine wave
exhaustion. This usually translates into a minimum of seven pivots when going with
the trend, followed by five pivots during a correction. Sometimes the market will not
cooperate with these technical assumptions but it can occur often enough to provide
some very lucrative trading opportunities.

By combining the moving average diagnosis with the pivot count and then fine-tuning
the analysis with an observation of candle patterns, a trader can stack the odds of
making a successful trade in his or her favor. Remember that trading is a craft, which
means that it is both art and science and requires practice to develop consistency
and profitability.