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A Complete Guide to Trend Trading and Identifying the Types of Trends

05 Sep 2023

When it comes to stock trading, there are different strategies to maximize gains. Trend trading is one such strategy that involves the identification of a trend and then investment according to the identified trend.

To understand the trend trading strategy, let’s understand what the trend means.

What is a trend?

A trend is a movement in the asset’s price in anyone particular direction. For instance, if the price of Stock A rose three times in a month, the stock is said to be experiencing an uptrend or an upward trend, since the price is moving consistently in the same direction.

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Types of Trends 

Essentially, there are three types of trends that an asset can experience:

  • Uptrend–when the prices keep increasing consistently
  • Downtrend—when the prices keep falling consistently
  • Sideways trend–when the prices remain static and do not change much

What is Trend Trading?

Once investors identify the trend in a stock’s momentum, they use the trend to trade and get returns. This method of trading in an asset is called trend trading.

Here’s how trend trading works–

  • In the case of an uptrend, the asset’s price hits higher swing highs and higher swing lows. In such cases, traders go for a long position to maximize the potential returns from the asset’s upward price movement.
  • In the case of a downtrend, the asset’s price hits lower swing highs and lower swing lows. In these cases, traders opt for a short position to minimize losses and get returns from slow movements.
  • In a sideways trend, traders either do not trade in the asset or trade cautiously, per their expertise and analysis.

Traders invest according to the prevalent trend and stay invested until the trend reverses.

Benefits of Trend Trading

Some of the benefits of trend trading are as follows:

  • Trends are lagging indicators that use historical price movements to recognize the trend. As such, trend trading is predictable, as investors expect the asset’s prices to move in the same direction.
  • The strategy is suitable for all types of investment horizons–short, medium, or long-term
  • By keeping an eye out for trend reversals, traders can limit or minimize their losses
  • Various types of technical indicators are available to assess the current trend of the asset. Common examples include moving averages, the RSI (Relative Strength Index) indicator, MACD (Moving Average Convergence Divergence) indicators, etc. Investors can use these indicators to identify the trend and the entry and exit points.

The Bottom Line

Trend trading is a simple and popular strategy that helps you bank on a current trend and generate returns. Understand how the strategy works and keep an eye out for reversals to minimize possible losses.

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