Technical trend trading requires you to draw lines of support and resistance. Typically you will use support as a spot where if it closes below, you will sell, as this is evidence of a trend break. You may cover your shorts if it breaks the resistance trend as the trend likely will form a new trend upwards. Be aware that the anticipation of new trends due to breaking of support or resistance is instead called breakout trading. You can still trade breakouts or breakkdons of price patterns and continue to trade the trend as it emerges, as opposed to trading the breakout or breakdown for a “swing trade”.
Trend Trading Breakouts
In a swing trade, you compare the average swing in that particular stock, buy on a breakout and sell when it hits your target. As a trend trader, you still may set targets, but you generally will sell if the trend is broke.
An illustration is really needed to show you.
Consider the chart below. See how the price pattern forms a new trend and new resistance and support is formed? There are many ways to trade trend but the premiss is you expect the movement to continue. (coming soon)
Channeling stocks, or Channel Trading The Trend
Buy low, sell high. There are many trends upward in which you will notice form a price channel. This allows a trend trader to consider buying more shares everytime the stock hits support, and taking some profits by selling a portion of your shares when it hits resistance.. You can usethe trend for risk management as you will buy at one price at the support, but if the stock closes below support, you sell before the end of the day so that you can avoid a gapdown and a breakdown of the trend.
Why Trend Trading Works
Why Trend Trading Fails
Aside from the fact that a trend break means that either the sellers or buyers have taken control breaking the pattern, trend trading as a whole can fall apart. This usually happens when trend traders are too predictable. Anytime a strategy becomess too popular there is someone willing to exploit it. If you knew that people were going to buy at a certain price and sell at a certain prce and you had enough money that you could control the markets, you could bet against them. You would be able to buy before the trend hits support, knowing that if the stock goes lower they’ll buy, and sell before it hits resistance and this sometimes happens naturally. That usually results in a flag or a pennant price pattern where a wide pattern or channel becomes narrow. Eventually there becomes no room left to trade, and the buyers and sellers get impatient. If buyers then emerge on strong volume, this is evidence of strong conviction. The stock will generally form a new trend higher. If sellers emerge on volume, this may be the start of a new trend lower. However, other strategies may occur. Perhaps people will sell the stock at support so that it breaksdown, as they know the trendtraders will then all sell lower. Once the price of the stock is lower, and the bulls are out and the sellers have taken the price of the stock down, then long term investors can accumulate shares at lower prices. Sometimes they might just want to rend trade and just do so below support, and this is when selling pressures increase. Sometimes sellers try to gain control and the buyers do not have the conviction initially, but then they come in buying hand over fist later. In many instances one group of buyers is trying to outsmart the sellers, and vise versa. This can result in stocks occasionally seeming really random as just whn you notice a pattern it collapses. Trading is almost never easy and predictable. The moment it becomes predictable, someone can exploit those who believe a trend will continue.
Fundamental trend trading
Fundamental trends can be used in a number of ways. In one instance, a stead increase in sales and/or earnings may indicate that a company is coming around. A steady increase in demand, regardless of how the stockprice moves may be a reason to buy. a trend in one area may indicate that another area is going to go higher. If governments spend, lower taxes, increase stimulous, and debt pressure is low, but more people take on debt and more money is created while the upply is becoming scarce, prices will generally become higher just about everywhere that there is scarcity. Following a fundamental trend is different then trading the price trend, however following fundamental trends may cause a price trend. For example, if the trend indicates that the business will increase it’s bookvalue and earnings by 20% every year, you can expect the company to be worth 20% more every year. As such, you can compare the market cap to what the stock will be worth in 10 years, and you can compare it to other companies. If the price is cheap enough, you will buy more shares. If you follow a trend, you will want to buy it at the low points even as a stock goes higher, provided those points are low enough.
Lets say a company is priced at it’s book value. It expects steady earnings of 2 billion a year for 10 years. It currently has a book value of 40 billion. In 10 years it projects to be worth 60 billion if the trend of steady earnings continues. Over 10 years this yields to be a 15% per year increase of book value as the book value will have increased by 150% total over 10 years, or 15% per year average. If we assume the stock will reflect the intrinsic value, this means we can expect a 15% per year investment IF the stock was priced AT it’s book value. So if a 15% per year investment is your goal, the stock might be worth buying at or below a market cap of 40 billion. If it averages 2 billion per year in earnings, then we can actually average each month to be 2/12 or .167 billion, or 167 million per month. So if the stock is currently priced at a market cap of 50 billion, it would only yield 12% per year, which means the stock isn’t cheap enough to qualify. However, if the stock is still at the current price 1 year from now, or 5 years from now, and the trend continues, we can expect the stock to be cheap enough. Not because the market cap is cheaper, but because the bookvalue will grow. So how many months will we have to wait? The book value will have to increase enough so that the book value divided by 50=1.5 which will average out to be 15% per year. Using algebra x/50=1.5 or 1.5*50=x. That means that 1.5*50=75. We need a book value of 75 which is 15billion greater than. Assuming a 167 Million increase in book value per month and 15/.167=90 months or 7.5 years. So the stock can either decrease from 50billion market cap to 40billion (a price decline of 20%), or the stock can be flat for 7.5 years. If both the stock declines as the fundimentals stay the same, the gap will close.
Additionally, if earnings growth is predicted rather than the markets staying flat, the picture of the stock in 10 years will change dramatically. An example would be if there is a 10% growth forcasted over the next 10 years. That means that instead of 20 million over 10 years, the bookvalue will increase roughly 31.87 billion. That means that instead of being worth an estimate of about 60 billion in 10 years, it will be worth 71.87Billion. If you compare that to a market cap of 50billion now it yields 14.375% per year, and only will need to fall in market cap by about 4%.
By following the fundamental trend our minimum buypoint will increase overtime if we expect constant earnings. If we expect earnings growth and the trend points to higher and higher earnings, we can expect to be willing to have a minimum buypoint that increases over time at a slightly increasing rate provided the trend still continues. This is often what forms actual price trends, institutions are figuring out the value of a company and how that company projects. In addition other investments may become more attractive so even if a company becomes more valuable, it still could sell off if there is a better investment out there.
If you look at things thisway and consider reading the fundamentals as “trend trading” then in some aspects Buffett can be considered a trend trader. However, he also throws in the intangible value of the company and finds a way to value it. In addition, he doesn’t trade, but instead will invest. He won’t sell if the stock becomes priced so that the trend will yield him less than 10% for example.
Additionally rather than follow the trend of earnings, he will instead find predictable earnings that should remain consistent, forecast the future, and buy for the long term, possibly holding the stock forever. This means he doesn’t have to actually constantly make adjustments.
The example in which a stock suddenly becomes worth a 10 year forward book value of 72billion rather than 60 billion by a mere 10% per year forecast, means that a stock can change in value in that example by 20% simply with a earnings revision estimate increase.
This is actually the reason why zacks.com is a website that is dedicated towards following earnings revisions, as trading stocks that have recently had upwards revisions can be very profitable.
[...] how to trade and perform other actions with free practice accounts. In order to get involved in trend trading, you will need to know the ins and outs of Above the Market. For investors to buy and sell their [...]