Trading with the trend is one of the most popular and widely used trading strategies among retail and institutional traders alike. But what exactly is trend analysis and why is it so crucial for trading success? This comprehensive guide will teach you everything you need to know.
What is Trend Analysis in Trading?
Trend analysis refers to the technical analysis strategy of studying the direction of price movement to determine the overall market trend. The core assumption is that prices typically move in trends, and by identifying those trends early we can trade in the overall direction of the momentum.
There are generally considered to be three market trends:
- Uptrends – Price is making higher highs and higher lows over time.
- Downtrends – Price is making lower highs and lower lows over time.
- Sideways/Rangebound Trends – Price is moving within a specific price range, with no clear direction.
By studying price charts and indicators, technical analysts aim to identify emerging trends early and capitalize on the likely continuation of trends until clear reversal signals appear.
What are the Main Trend Trading Methods?
There are two primary approaches traders use to trade with trends:
1. Follow Trend Signals from Trend Indicators
Trend indicators are mathematical analysis techniques that utilize historical price, volume, and momentum data to determine trend direction and strength.
Some of the most popular examples include:
- Moving Averages – Compares price to an averaged benchmark to identify prevailing direction
- MACD – Moving Average Convergence Divergence identifies momentum
- ADX – Average Directional Index measures the strength of a trend
By combining trend signals from indicators, traders aim to objectively identify and measure trends.
2. Price Action Analysis
Price action traders rely primarily on the analysis of raw price data to spot trend patterns. This may involve techniques such as:
- Identifying higher highs and lows in uptrends, lower highs and lows in downtrends
- Connecting swing points to draw trend lines
- Spotting classic reversal chart patterns
Through visual inspection of charts, price action traders aim to manually identify trending moves.
How to Confirm You Are Trading in the Direction of the Trend
Since no trend lasts forever, confirming an emerging trend before trading helps avoid false signals and catching corrections too early. There are three key ways traders confirm trends:
- Use multiple timeframe analysis – Identify alignment of trends across higher and lower timeframes.
- Wait for pullback entries – Enter retracements back to broken trendlines/moving averages.
- Have strict stop loss rules – Set stops below the structure to invalidate trade if the trend breaks.
Aligning signals across short-, medium-, and longer-term time horizons provides higher probability trend trades. Entries are safer after pullbacks rather than chasing price extensions. Stop losses and defend against unexpected trend failures.
Is Trend Trading Profitable?
Following the trend has shown to be an extremely profitable trading approach over long time horizons. One of the most famous global macro traders, John W. Henry, amassed an enormous fortune using pure trend-following strategies.
However, profitability depends greatly on the trader’s skill in promptly identifying new trends, avoiding false signals, managing trades and adapting to changing market conditions. Mastering even one particular trend trading strategy takes considerable screen time.
Common Trend Trading Strategies
Beyond the core trend trading methods mentioned previously, there are endless trend strategies traders utilize to capitalize on market momentum. Some of the most popular include:
Trendline traders identify areas where the price is making a series of higher highs and higher lows (uptrend) or lower highs and lower lows (downtrend), then connect these swing points to draw a trendline.
They will look to enter long trades on bounces from the trendline support in uptrends and enter short trades on drops from descending trendline resistance in downtrends. Stops are placed on the other side of the trendline.
Moving Average Crossovers
This strategy utilizes two moving averages – one longer term and one shorter term. The trader goes long when the shorter average crosses above the longer average, signaling an uptrend, and goes short when the shorter average crosses below the longer.
So a 50 EMA / 200 EMA strategy for example capitalizes on the faster average crossing over the slower one which indicates momentum accelerating.
Price Channel Breakouts
Price channels identify ranges bound by parallel support and resistance trendlines. Traders analyze the slope of the channel to determine if it’s an ascending bullish channel or descending bearish one.
When the price breaks above bullish channel resistance or below bearish channel support with increased momentum, traders will enter continuation trades in the direction of the initial channel slope.
Using Indicators to Confirm Trends
As noted previously, indicators like moving averages and MACD can define both direction and strength of emerging trends. But they can also be used to confirm trend pullback entries.
For example, entering long on pullbacks to a rising 50-day moving average or when MACD shows bullish divergence at swing lows. Confirming indicators boost confidence in trade entry timing.
There is an unlimited combination of trend trading techniques. Finding a strategy that suits your trading plan and style is key to executing it consistently.