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Trend Following Techniques
by TimRacette 07-13-2011, 11:52 PM

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We’ve all heard the saying…

“The trend is your friend until the end”

In this post I outline techniques for identifying the trend, getting in, and staying in until it fails.
How do we Define a Trend?

An uptrend can be defined as higher highs and higher lows, while a downtrend can be defined as lower highs and lower lows.

As an exercise, each night print out a 5 or 15-min chart of the market you are trading and identify the key highs and lows of the day. After a few weeks you will become better able to define the trend during the day.

Methods for Identifying the Trend
Moving Averages
Regardless of the time frame you’re trading, moving averages are a great way to quickly identify the general trend of the market. I place more weight on larger time frames such as the daily and weekly and then look to trade with that trend on the smaller intraday timeframes.

A 20-period Exponential Moving Average is a great tool for intraday trading.



A 20 Period Exponential Moving Average (in blue) helps quickly identify the larger trend. Using a 5-min chart, the 20-EMA keeps us aware of the larger trend.

Candlestick Patterns
As talked about in the book Japanese Candlestick Charting Techniques, candlestick charting is a great way to identify market sentiment and trends. The candlestick pattern is made up of an open, close, high, and low price. These candlestick patterns have a lot more to say as compared to a bar chart. To get an even clearer picture of the trend try switching to a Heikin Ashi chart.

Methods for Entering the Trend
Fibonacci Retracements
Buying on a retracement as opposed to chasing the market is a great way to enter a trend. This reduces the likelihood that your stop will take you out. Once you have identified a new trend try drawing from lows to highs (in an uptrend) and waiting for a pullback to the 50% of a Fibonacci retracement before going long.



Entering a trade at a 50% Fibonacci retracement is a low risk method of getting into the trend. This allows you to enter on a pullback rather than chasing the market.

The NYSE Tick
This is by far my favorite tool for intraday trading. To learn more I will refer you to my prior post on the NYSE Tick.

Reversal Patterns
Buying over the high of a low bar (in an uptrend) or shorting the low of a high bar in a down trend is a great way to get in the new trend close to a reversal. These patterns accompanied with a moving average or other momentum indicator can be a sound strategy with very good risk/reward ratio.

Whether you’re an intraday trader or use a weekly chart, being able to identify the trend, get in, and stay in will yield the greatest return over time.

Do you have other methods for identifying the trend?

I’d love to hear from you.
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Old 07-14-2011, 10:07 AM   #2

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Re: Trend Following Techniques

If you are trading stocks, you should look at both the overall market trend and the trend of the individual security. The Edge is better if you trade stocks from the long side when the market is trending up and conversely.

It's also useful to look at the rate of change in the trend as observed by the steepness of the chart, regression lines or RSI indicator. When the market and the stock you are stalking are in strong up trends, it is often better to use a breakout approach for entering a position rather than waiting for a pullback. Breakouts can be defined many ways, e.g. when the price penetrates the upper Bollinger Band, or makes a new high for the past 'n' days.

But, trading breakouts is risky and you should always know how much you're willing to let the price pull back before you exit the trade. Set real stops unless you are watching the action constantly.
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Old 07-14-2011, 11:35 AM   #3

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Re: Trend Following Techniques

Great thread, Tim.

I agree that 20 MA is the easiest way to identify a short term trend. 60 MA and 200 MA are good tools to identify mid and long term trend.

To me, however, the most difficult part is to stay in the trend and get out at the reversal (not too early, not too late).

Nicolas Darvas has this box method to monitor his trade. This method works pretty best in a bull market with weekly chart, but less than satisfactory in a sideway market, where most of the trends are short term trend. When you trade on lower timeframes, there are more market noices and you will be stopped out more often than with larger timeframes.

Even with a long term trend, it is difficult to decide whether the retracement of the price is merely a pullback or a reversal.

So when to get out? Anyone has any thoughts there to share about?

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Old 07-14-2011, 07:45 PM   #4
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Re: Trend Following Techniques

Quote:
Originally Posted by KT Lin »
Even with a long term trend, it is difficult to decide whether the retracement of the price is merely a pullback or a reversal.

So when to get out? Anyone has any thoughts there to share about?

KT
This applies more to longer term trends but generally is applicable to any trend

if you are trend trading the default position when you are in a position/trade is to let it ride (otherwise you are not trend trading)
So when it comes to getting out when trend following you will naturally always have drawdowns of equity after a big run up. You are not meant to be trying to pick the top or bottom
OR, you had better have a pretty good method of re-entering the trend if you have levels to get out......unfortunately this is the trade off you face.

when it comes to getting out after following a trend for a long time - you often have plenty of time - trends dont often reverse without some form of consolidation.

Personally I have always struggled with this due to the trade off involved, but I have found that the first big pullback after a trend (lets say an uptrend and big pullback is -- price crosses over a few swing lows, or hits a MA, or a lower donchian channel) gives an indication (a very big indication) that its time to exit a trade on further rallies, rather than have any hard and fast rules to exit on the first draw down......but this does not mean trying to then short....
Curtis Faith covers this in his book Trading from your gut....in it he talks about the combination of auto trading a system with using instinct to exit with out being too dogmatic
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Old 07-16-2011, 08:04 PM   #5

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Re: Trend Following Techniques

I've been lurking for a while hoping to hear from others who trade longer term. I consider myself to be a trend trader. There are lots of definitions for a trend depending on the time frame one is using. I trade from the weekly chart and move to the daily for confirmation and specific entry. I screen for stocks/etfs that have been in a trend within the past year, have reversed or consolidated and are now beginning to move higher again. I look for price to close above the 8ema on the weekly chart for two weeks and the fast macd to have crossed over it's signal line. I then go to the daily chart for a specific entry point and to determine my stop/risk.

Once in the trade, I hold and view the action on the weekly chart waiting for a specific signal that indicates to me the trend may be ending. Trading from the weekly chart eliminates much of the noise and allows me to stay in a trade longer. I've discovered when I traded on shorter time frames, I often times entered and exited trades either too late or too early. The longer time frame has allowed me to "see" the trends more clearly.

I'm interested to hear from other longer term traders. What works for you? How do you determine your entries and exits?
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