Last Updated on 10 February, 2024 by Rejaul Karim
“What’s trending” is the new phrase of the 21st century and we all want to be part of things that go viral. While most of us are suffering from the fear of missing out or FOMO, traders and investors are following trends for another important reason: to be part of the winners’ team and have a better financial gain. Trend following is something quite often used in trading. Also called trend trading, it is an efficient strategy for investors as they know when to buy an asset and when to sell it. The trend following is based on the price movements on the market.
Trend following works best when the market is in good shape. You need to have a basic trading strategy to follow and must look at common market indicators to ascertain where the market is headed. When all indicators like MACD, Morning Averages, OBV, RSI, etc. are showing the uptrend, you should indulge in trend trading. Investors and traders will not have the best results when the market is choppy.
While trend following depends greatly on these factors, it’s also important to build a trend following strategy and observe the price movements and market changes in the long run.
How to build a trend following strategy?
When you practice trend following, it’s important to build a strong trend following strategy. Here are a few tips to consider in this regard:
- Trade more markets: following trends is challenging, and if you do it on the same market, you may not have much activity. Trading several markets will definitely keep your trend following strategy going. Try bonds, indices, energy, currencies, metals, meats, agriculture or interest rates.
- Take some risk: in trading, it’s important to also take some risks. As a trader, you know probabilities are what you are in for. The best strategy is to always take little risk on every trade you make. However, keep it safe and don’t risk more than 1% of the entire account when you make a trade.
- Know your moment – in trading, it’s all about momentum; knowing when to enter a trade and when to exit a trade if you win or lose turns out to be the key to success. There are various methods out there, but you should choose the right one for you. Always remember the two basics: you should be covered when you lose and you don’t need to stay too long when you are winning on a trade. Keep it balanced.
Building a trend following strategy based on these tips is great, but not complete without the right indicators to watch on the market.
The most important indicators on the market
If you want to know when the market is in good conditions, make sure you watch these indicators. These will offer you an overview of what happens on the market and help you find the best moments to trade.
- Morning averages
One of the most used indicators is morning averages. Many traders use this indicator to build their trend following strategy. Morning averages is the basis of a long-term strategy because it implies using historical data for the observation of price fluctuations. How does this help? An investor can use this data to observe the trend flow and price situation over time so he will make the best decision.
- Bollinger Bands
The second indicator of the market you should use when building a trend following strategy is Bollinger bands. These are indicators for the price movements in a particular stock. The Bollinger bands are actually 3 lines that represent different things: Upper & Lower Bollinger band that are two of the standard deviations of the average. These two bands measure the volatility of the fluctuations on the market. They are very useful for an investor who wants to follow the good trends. The middle band is the band that completes the trio.
MACD or Morning Average Convergence Divergence sounds complicated, but it’s quite easy to understand. This is actually a comparative analysis that involves 2 moving averages with 2 datasets. The comparison is made with the help of three observations: divergence, convergence and dramatic rise.
RSI or Relative Strength Index is used by traders and investors in trend following. RSI helps traders measure change and speed of the price movements. This indicator can give you a hint about the recent performance of a security on the stock market. You can find out how strong a stock is, from zero to 100. The basis of this indicator is the following formula: RSI = 100 – 100 / (1+RS)
OBV or On Balance Volume is also an often-used indicator that measures volume flow to see what direction a trend has. OBV is a momentum indicator that shows investors and traders if the prices are rising or falling. Because price rise and volume are directly proportional, a falling OBV means the price is also falling; also, a rising OBV means the price is rising as well.
Trend following on multiple markets
Many traders don’t choose one single market to trade, but following their trend strategy on multiple markets. This gives better chance in succeeding and finding great stocks to increase the revenue.
Trading on multiple markets is not easy, but it’s a profitable way to implement your trend following strategy. However, different markets have different traits, which requires more research and knowledge of these. Some markets are more suitable for trend following, while others work better with classic investment strategies. Knowing which markets to approach is vital to the success of your trend following strategy.
Before you start implementing your trend following strategy, ask yourself a few questions: What will you trade? Will you choose the safer commodities, stocks or futures? What type of market are you more comfortable in? Do you want to diversify your portfolio and go for other markets as well? You can go for commercial fields as well, such as Softs, or for more industrial ones, such as Agriculture or Energy.
So, in order to create a responsive and successful trend following strategy, it’s important to choose your markets well. Where should you apply your strategy? Here are a few examples for you to get started:
- Energy – focus on natural gas or oil;
- Agriculture – focus on corn, wheat, soybeans, etc.
- Softs – focus on sugar, coffee, cotton, etc.
- Mutual Funds
- Interest Rates
What you need to understand about trend following is that it doesn’t require in-depth knowledge of the markets you are going to trade on. However, the expertise of a trend follower in trading is to use analysis and price to trade the trend and get the most out of it. Plus, keep in mind that nobody can ever predict which market will the next big trend be on. That’s exactly the reason why you need to diversify and mix it up. Be there and you might catch the next trend as it’s born.
The main idea is that trend following is challenging but also fun. There are ways to predict if there is a trend on the rise, but in the end, you cannot win if you don’t risk it just a little bit. Choose diverse markets for your portfolio, build a creative and well-thought trend following strategy and start looking for those indicators that let you know the market’s shape in that moment. Don’t forget to build tactics that will help you know when to get out of a trend if you are losing and when to get out of a trend when you are winning. It’s important to keep some control over your actions as a trader.
In the end, trading is not all about numbers, but also about having some fun. Plus, as the trend following method requires more flexibility and diversity, go with the flow and enjoy this unique trading experience. You are on your way to the next big trend in trading, just keep on playing your cards until you get it right.
How does trend following work in trading?
Trend following works by monitoring market indicators like MACD, Bollinger Bands, RSI, OBV, and morning averages. When these indicators show an uptrend, traders engage in trend trading to maximize financial gains.
What makes a strong trend following strategy?
A robust trend following strategy involves trading multiple markets, taking calculated risks (typically not exceeding 1% of the entire account), and understanding the importance of momentum in entering and exiting trades.
How can I build a trend following strategy?
To build a successful trend following strategy, consider trading diverse markets such as stocks, bonds, currencies, commodities, and cryptocurrencies. Additionally, use indicators to gauge market conditions and ensure a well-thought-out plan that includes risk management.
Do I need in-depth knowledge of each market for trend following?
While in-depth knowledge is beneficial, trend following doesn’t necessarily require it. The focus is on using analysis and price movements to trade trends effectively. Diversification across markets helps capture emerging trends without predicting specific market behaviors.