Whether long-term or short-term, market investments are exposed to certain financial risks. Traders follow the trend trading technique to minimize these risks and get maximum returns from investments.
What is Trend Trading?
Trend trading is a trading style that helps a trader capture and analyze the movement of the stock price in a particular direction, both upward or downward. You can identify the trend with the help of tools that highlight the price movements in a particular direction and classify them into ‘Uptrends’ and ‘Downtrends.’
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What are Uptrends and Downtrends?
- Uptrends: Under this scenario, the stock price tends to move upwards and exhibits higher swing lows and higher swing highs. The price stock movement need not necessarily be upward moving at all times; it can have its fluctuations. However, the overall movement should be upward for the stock to remain in the uptrend segment. Traders usually buy in an uptrend.
- Downtrends: Under this scenario, the stock price tends to move downwards and exhibits lower swing lows and lower swing highs. Traders generally prefer to sell stocks or undertake short trading in a downtrend to minimize losses. However, not all traders resort to selling or shorting; some view a downtrend as a price bargain and choose to buy more stocks at a lower price.
Both these trends help the investor decide their course of action. Some trade in the same direction of the trend to make profits, while others, known as contrarians, identify reversals and choose to trade against the trend's direction.
How to Identify Trends?
Investors may identify trends based on the following parameters:
- Fundamental Analysis: This type of analysis helps the investor identify trends based on factors like changes in revenue, EPS, and other business or economic metrics.
- Trendline: Trendline analysis helps the investor to identify trends by connecting a series of higher lows for uptrends and a series of lower highs for downtrends. Connecting a series of higher lows (uptrends) creates a support level for price movements in the future, whereas connecting a series of lower highs (downtrends) creates a resistance level for price movements in the future. However, trend lines are not accurate for trend identification and should not be relied upon completely.
- Price Action: This analysis tool helps the trader identify trends based on rising and falling price levels beyond a benchmark.
If you are investing or trading in market-linked assets, understand the concept of trend trading. Identify market trends when making investment decisions so that you can minimize the chances of loss and enhance the return-generating potential of your portfolio.
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