Thursday, April 11, 2013

The Trend is your friend

By Dean Watt

A trend - why follow a trend?

In its most basic form a trend is the direction the market is moving. The market either moves up, down or sideways. When the trend is up we are looking to buy into the market. When the market is down we are looking to sell.

When the market moves this can be be seen as zigzag pattern of peaks and troughs. This is the flow of the market and shows the relationship between supply and demand.

When the peaks and troughs are getting higher and higher we are in an up trend, and as long as zigzags keep getting higher the trend will continue. When this happens we can set up a buy position and let the rising market make us money.

The reverse is also true of a down trend. If the peaks and troughs are continually moving lower we have a down trend. We can open a sell position and let the dropping market make money for us.

When the market is moving sideways it is called trend-less. It will move between two points in the market and it will stay between these points until a trend develops. This can be a difficult time for a trend following system as it can lose money. A trader can use a sideways trading system during these times and buy (bottom) and sell (top) at the top and bottom of the trading range.

When we know how a trend moves we can use this information to make us money. However we need to understand that different time frames can produce different trends at the same time.

In technical trading there are 3 time scales used with trends. There is the major trend which lasts over 6 months. An intermediate trend which is between 3 weeks and 6 months and lastly there is the near term trend which is under 3 weeks.

The type of trend we are trading depends on the time frame we are using. We may have an up trend in the monthly chart but a down trend in the daily chart. It is essential that we understand the time frame and the trend we are trading.

When we hear the news or use our favourite financial website they may talk about a trend. To be able to profit from this information we need to know what time scale they are talking about. Otherwise the information they are providing will not help us.

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