Trend Trading

Definition of a Trend

Trend:  New World Dictionary "To have a general tendency: said of events, conditions, opinions, etc. General direction. The general tendency or general direction of course, as of events, a discussion, etc."

In the financial markets, a trend is generally understood to be current market direction. Markets can be trending higher, trending lower, or trending sideways.

But defining a trend so that it can be profitably traded is something else entirely.

Many would say we are currently in a bullish trend. But are we? The S&P 500 has been within a 7% trading range for 4 months. The Nasdaq has been within a 10% trading range for 5 1/2 months. If that is a trend... it is a "sideways" trend.

Even the chart of the Russell 2000 Small Cap Index, used below to demonstrate trends (and which had an undeniable rising trend from March to December of last year), has been moving sideways for 4 months.

Just saying that a trend consists of "rising" prices, or "declining" prices is not enough. Every day is different. A trend must be clearly defined in order to be profitably traded.

And what about time frame? Are we talking about a trend on a 5 minute bar chart where it could last an hour? Or is it of longer duration; days, weeks, years?

In the financial markets, many analysts would define a trend on a "daily" chart, as prices that are "above or below a 50 day moving average." The below daily chart of the Russell 2000 Index is marked with a simple 50 day moving average. The "big picture" trends are obvious in this chart.

However profitably trading them is something entirely different. It is easy to determine trends on a chart of prices that have already occurred. Developing a trading strategy that will keep you on the right side of "future" trends is needed to profit from trend trading (market timing).

Successful market timers know several facts about trends that give them an "edge" in trading them:

1.  While financial markets may spend time in consolidation (sideways trends), they are more often moving up or down for sustained periods of time.

2.  A timing strategy that defines trends can be used to take advantage of continued momentum in the market place.

3.  Trends tend to go higher, or lower, than most investors expect. So correctly identifying and trading a trend can be very profitable.

4.  Profitable trends occur only once or twice a year. The rest of the time the markets trend sideways. The S&P and Nasdaq, for example, would have to be considered as being in a sideways trend over the past several months.

Because tradeable trends (see above chart) only occur once or twice a year, market timers must be prepared to sometimes wait months before catching that one highly profitable trend.

a.  To be consistently successful over time (minimum 1-2 years time frame), market timers must have clear rules telling them when to enter, and when to exit.

b.  Market timers usually make the majority of their profits in only one or two trades a year.

c.  When the markets are in a bullish or bearish trend, trading position changes may not occur for months at a time as the trend progresses.

d.  When in a sideways trend, market timers often have multiple trades that result in small losses, or small gains. These small losses and gains "must" be accepted because timers "must" trade every identified trend change. There is no way to know "ahead of time" which trend will be the highly profitable one.

e.  A profitable trading strategy will "not" allow a market timer to miss that trade!