Trend is your friend! As cliche as it sounds, it is completely true. It is much more likely for a trader to make money in the stock trading if he/she focuses on riding the trend. But how can a trader make use of the trend? Before learning how a trader can profit from a trend, let’s understand what stock trend means.
What is a trend in stock trading?
Trend is exactly as it sounds! Just like there are new fashion trends – e.g. there could be a type of jeans which is becoming popular nowadays or there could be winter clothes which are becoming popular due to the upcoming winter. Whatever the reason, a trend represents what is popular & common nowadays.
A trend represents the overall movement of the stock over a time frame. It essentially means how a stock has behaved in the recent days/weeks/hour/minute (the time depends on your timeframe). Is it more common for the stock to go up day after day or is it popular for the stock to make new lows every single day? That’s what a trend tells us.
If you see a stock which is getting cheaper & cheaper everyday, it is likely in a downtrend. On the other hand, if you see a stock getting more & more expensive with each passing day, it is likely in an uptrend. Basically, is it popular to buy or sell the stock nowadays? That question is answered by the stock trend.
The mistake which beginner traders make!
The biggest mistake which new traders make is to take a stand against the trend. They like to go against the overall market sentiment which causes them to lose money in the market! Many beginners think that if a stock is falling every day, then they should buy the stock because it is available for a cheaper price. Eventually the stock will turn around, right? WRONG! As a trend trader, your job should only be to do the most common thing which is happening i.e. follow the trend.
As a trader, it is always recommended to take a long position in a rising stock & short position in a falling stock. If you are unaware of Long & Short positions in stock trading, visit this article! Going against the trend is equivalent to standing in front of a train which is running directly at you. You will get CRUSHED!
How to identify the trend of a stock?
There are a couple of simple methods which a trader can do to identify the trend of a stock.
1. Swing highs & lows
Swing highs & lows allow a trader to understand the overall movement of the stock. A higher high & higher low shows that the stock is in an uptrend.
Notice, every new high is higher than the previous high. Similarly, every new low is higher than the previous low.
Similarly, a stock which is continuously forming lower higher & lower lows is in a downtrend.
Notice, every new high is lower than the previous high. Similarly, every new low is lower than the previous low.
The method of checking the highs & lows to find out the trend of the stock applies to every single stock chart & every single time frame.
2. Moving average
A moving average can also be used by a trader to understand the trend of the stock.
For a stock in uptrend, the moving average (typically 20/50 SMA is used depending on aggressive/defensive traders) should be rising & the stock should be trading above the moving average.
It can be seen that the moving average is rising & the price is currently trading over the moving average.
For a stock in downtrend, the moving average (typically 20/50 SMA is used depending on aggressive/defensive traders) should be falling & the stock should be trading below the moving average.
It can be seen that the moving average is falling & the price is currently trading under the moving average.
Moving averages provide a quick insight in the overall movement of the stock & can be a useful tool for a beginner to understand the trend of a stock.
To learn more about the usage of moving average in trend trading, visit our Intraday trading playlist on YouTube!
How to ride the trend?
There are two common methods for a stock trader to ride the trend – pullbacks & breakouts. Both methods can be seen commonly in stocks & can be exploited by traders for a nice profit. Let’s discuss both methods in detail.
1. Pullback
Pullbacks refer to the movement of a stock against the overall trend of the stock. Let’s suppose that a stock is currently in an uptrend, then the small movements which cause the price to fall will be considered a pullback. (NOTE : the movements against the trend should be smaller than the movements which happen along the trend for obvious reasons)
Pullbacks (highlighted in orange) show an area where the stock has moved against the overall trend & has come closer to the moving average. These areas can be used by traders to take up a potential long position to capitalize on the trend of the stock!
Similarly, such pullbacks can be observed during a downtrend where the stock moves opposite to the overall trend closer to the moving average.
Such increase in prices can be used as potential short positions by traders.
A pullback is simply the market providing you an opportunity to enter the overall trend of the stock. Suppose you want to enter into a long trade in a rising stock, pullbacks are simply discounts which a trader capitalizes on to enter the trade! The same is true for taking up a short position in a falling stock.
2. Breakouts
Unlike pullbacks which are small movements in the stock against the overall trend, a breakout represents a powerful movement in the stock along the direction of the trend. Breakouts are most profitable for a trader when they occur after a long consolidation in the stock.
Here is an example of a breakout after a consolidation which caused the stock to break the resistance with a powerful move!
This example shows a stock which was consolidating within a small range (highlighted in black) which was followed by a strong up move (highlighted in orange) causing the stock to resume its uptrend.
Here is an example of a breakdown (breakouts in the short position are called breakdowns) which caused the stock to break the support with a powerful move!
This example shows a stock which was consolidating within a small range (highlighted in black) which was followed by a strong down move (highlighted in orange) causing the stock to resume its downtrend.
Conclusion
Pullbacks and breakouts are the most common methods which are used by traders to capitalize on a trend. A pullback is like a discount provided by the market to enter a trend in a safe location. On the other hand, a breakout (or breakdown) is a confirmation of trend resumption by the market. Both pullbacks & breakouts should be part of a trader’s arsenal to ride the trend. However, the final decision of trading depends entirely upon the reader.
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DISCLAIMER : I am not a financial advisor. I am not for or against any company which I have mentioned in this article. All the information provided here is for education purposes. Please consult a financial advisor before investing.
Contact me at investmentabshuru@gmail.com
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