TREND IS YOUR FRIEND
‘Trend is your friend’ is an adage that many beginning investors and traders hear often. However, learning to recognize and use a trend and profit from it is more an art than a science. Successful traders learn to recognize a trend early, and then hop on for the ride until the trend ends. Since major investment companies usually buy stocks over a period of weeks or months, a little at a time so as not to cause the price to sky-rocket quickly, trends often can exist for a long time.
TSL – A Moving Average Case Study
There are many ways to identify trends, including trend lines, moving averages, moving average cross-overs, etc. Some are easier to understand and use, and all traders develop preferences of what they wish to see on their charts. However, successful traders usually ones who learn how to apply the KISS principle (Keep It Super Simple). The following chart is an example of the application of moving averages and moving average crossovers to a candlestick chart of TSL (Trina Solar Limited). The chart depicts three exponential moving averages – the 8 (white), 50 (green) and 200 (magenta) day EMAs overlaid on a candlestick chart of the daily stock prices.
TSL – Trend is your friend
TREND IS YOUR FRIEND – CHOOSING YOUR MOVING AVERAGES
In essence, traders who use moving averages look for the action of price with relation to their moving average of choice, and for crossovers of short-term moving averages over long-term moving averages.
BUY signals are generated when the short term moving average crosses above a long-term moving average – as seen on 4/25/13 or 4/26/13 when the 8EMA crossed above the 50EMA and 200EMA respectively.
TESTING MOVING AVERAGES
Once a bullish trend has begun, the stock will often return to ‘test’ a moving average. Each bounce on a moving average and subsequent rise affirms the bullish outlook for the stock.
In the chart above, we see TSL returned to test the 20EMA on 6/24/13, then again on 8/7/13 and 8/19/13. The more often a stock successfully tests a moving average, the more validity it has for future tests. Of note, the last two tests were of the 20EMA on 8/28/13 and most recently on 9/13/13 (last candle on the chart).
Although the above example of TSL depicts a bullish trend, moving averages and moving average crossovers can be used on the down-side as well. In fact, astute traders play both the up side and down side with equal enthusiasm, often on a small basket of stocks or ETFs whose patterns they learn to recognize well.
A TREND IS YOUR FRIEND UNTIL IT ENDS
Trends can last for days, weeks, months or, sometimes, even years. No matter how one plays a trend, at some point, it will end. Learning to recognize the end is just as important if not more important than recognizing the trend is beginning, so as to ensure that one does not give back the profits one has generated.
How an investor or trader exploits a trend depends on his or her outlook. Swing traders may exit a trade within a matter of minutes, hours, a few days or weeks. Buy-and-hold investors may ride a trade for many months. To each his/her own!
A simple and effective method to ensure the emotion of GREED does not cloud one’s judgment is set a GTC order to close a portion of the trade when a certain target is reached. The target could be a minimum percentage gain, or a target price or a trailing stop, etc. (see ‘The Power of the GTC order’ for a real example). With the electronic broker instant messages nowadays, one will be informed when such a trade is triggered, and can check your brokerage online to set a new GTC trade.
Of course, greater profits might be obtained by choosing to option strategies to play the trends rather than buying or shorting stock outright (See ‘Winning Trading Strategies’).
Happy Trading!
JonLuc
