A Beginner's Guide To Trend Trading

Have you ever wondered how some of the greatest traders in the world became so successful?

Many of them utilize trend trading and trend following to become what they are now today.

Trading with the trend is one of the keys to stock market success.

Have you ever heard of the famous Wall Street maxim:

"The Trend Is Your Friend"

There is a lot of truth in this short saying. In fact if you follow it and respect it, the stock market will open up its riches to you. In this "Beginner's Guide To Trend Trading", I will show you:

  • How to identify a trend
  • How to know whether your stock is in an uptrend or downtrend
  • How to find the best stocks to buy using trend following
  • How to know when an uptrend ends
  • Learn a trading strategy to take advantage of the trend
  • How to put a stop loss and take profits

I will take you from beginner to more advance concepts so that by the end of this guide you will be ready to do your own trend following and profit from the stock market.

Are you ready?

Let's get started

What Is A Trend

The easiest way for you to understand what is a trend is to consider:

  • fashion trends
  • toy or gadget trends

Fashion trends come and go depending on the season and years and even decades.

Nobody really knows why certain decades have certain trends and why they become so popular. Perhaps it might start with a celebrity who starts to wear that particular piece of clothing. Soon more celebrities wear it. Then their fans begin to wear the piece of clothing and eventually it becomes hot.

There will come a time where the trend becomes so hot that it is on the lips of every women. Fashion brands and textile companies all compete to produce the best clothes for consumers. Then out of the blue, the demand for that piece of clothing dwindles.

Less and less people wear them and eventually those clothes and dresses get put at the back of the drawer. Companies slow down the production and eventually discontinue the clothing.

You can say that the particular piece of clothing is no longer in "trend".

How about toys?

I remember as a young kid in the 90s our favorite toy is the Nintendo and Sega. Remember those Street Fighter Games and Sonic the Hedgehog?

Every kid wants to own a Nintendo.

Teenagers and kids will spend hours and hours staring at the television set powered by the Nintendo.

Those were the days...and soon the trend for Nintendo and Sega was over.

Along came stuff like the Xbox.

In the early days of mobile technologies, everyone wants to own a Nokia and play "snake" with it. Soon came touchscreen hand phones and soon phones like the iPhone.

Today you can pack the camera, a phone, a game machine, a walkman, a personal assistant and many more into a small device called a smart phone.

You see my friends, trends come and go.

Things start out getting more and more popular, hits a peak and eventually it declines.

That is the nature of trends...

a beginner's guide to trend trading

Fashion trend, gadget trends and even stock trends follow the path above.

First, you will have a base and then as more and more people are interested in the subject, the trend rises. Trends can last for a few months to many many years. Eventually it will reach a peak. Then the trend will start to decline. Some trends may come back again but many do not.

Your job as a participant of the stock market is to learn how to identify trends and profit from it.

You want to be as early as possible and sell as it peaks.

If you are a sophisticated trader, you can learn to short stocks as it declines and profit from it.

The 4 Stages Of The Stock Market

In this section I would like to introduce you the 4 stages of the stock market. Every stock and index in the stock market will go through each of these stages. 

Pay attention to the next 2 diagrams as they will be worth its weight in gold to you. It will forever change the way that you approach the stock market.

In fact, you should print out these 2 diagrams and stick it in front of your computer. Let it be a reminder to you the next time before you buy a stock.

the 4 stages of the stock market

Every stock and every stock market index will go through 4 stages.

Stage 1 is where the stock bases

During this period the stock will not be moving that much. It trades sideways in a relatively tight manner. There is not much action and therefore not much attraction to this stock. The stock will not be known by many people. It has not been extensively covered by the financial press and therefore the public is not interested in the stock.

Stage 2 is where the stock begins its nice uptrend

During this period, the stock will be a big winner. It goes up and up and up. This is also where the financial media will start to begin lots of coverage on the stock. Stock market writers and bloggers and investing groups and channels will be all over this stock. Many commentators will tell you that this is the next Microsoft or Apple.

This is also the period where the trader and investor will make the most money. You buy every dip and breakout and ride the trend higher. Making money in the stock in this stage is relatively easy and smooth. It seems there is no end to the stock's rise.

Stage 3 is known as the top

During this stage, the stock will start to top out. Trading in the stock will be very volatile. The stock's price will fluctuate a lot intraday. It is not surprising that the stock can go up and down 10% in a single day. You will see a wide and whippy price action.

At this stage, the stock will be widely known and touted by lots of people. Everyone will be interested to make a quick buck in the stock. Some will start to tell you that you should buy more of this stock if it declines 20%. They never give up on the dream that this stock will shoot up another 100%.

However, the volatile price action is a sign that this stock is hitting a top. Smart traders and investors will be carefully unloading this stock into the market. Greedy investors who are ill informed will buy and buy this stock hoping it to go up more.

Stage 4 is where the stock starts a downtrend

After the stock tops out, it begins a downtrend. This is the beginning of the decline for the stock. You will begin to see that the stock starts to make lower highs and lower lows. Every time the stock tries to rally it is met by selling. Every time the stock tries to go up it will fail and eventually decline even more.

During this period, the uninformed investor will think they should buy more and more of the stock in the hopes that it will rise again. They refuse to believe that the stock has already topped out. Every time the stock goes down more, the public wants to buy more.

Smart investors and traders know that the stock is now in a bad downtrend. They will avoid buying a stock like this. In fact some will learn to short the stock each time it rallies and each time it breaks down.

What To Do In Each Stage Of The Market

Now that you know the 4 stock market stages, you will be more clear on what to expect in each stage.

Each stage has its own set of actions that you need to take.

If you do the right thing in each stage, you will increase the odds of your success.

The diagram above shows us the appropriate action to take for each stage that a stock goes through.

Even in the bible in the book of Ecclesiastes 3:1, the bible states that there is a "time for everything". The chapter goes on to give many examples in life.

When it comes to the stock market, there is also a right time to buy stocks and a bad time to buy stocks.

Here is a summary of what you should or should not do in each stage:

  • Stage 1 (Basing) - Stay Away
  • Stage 2 (Uptrend) - Buy Stocks
  • Stage 3 (Top) - Avoid Buying
  • Stage 4 (Downtrend) - Stay Away or Short Stocks

When it comes to trend trading, the above is the template for you to be successful in the stock market.

A stock that is basing in Stage 1 is trendless. Therefore, you should stay away from buying the stock. Avoid it. When a stock is in a Stage 2 uptrend, this is the best time to buy the stock. Since the stock is in an uptrend, the likelihood of it going higher is very big.

When a stock is at a Stage 3 top, one should avoid buying the stock. The stock is just moving sideways erratically and there is no nice trend in the stock. So its best to avoid the stock like the plague. Finally, when the stock is in a Stage 4 downtrend, you should not buy the stock. On the other hand, since the trend is down, one can benefit from short selling the stock.

Allow me to show you a live example of how the 4 stages of the market goes into action...

The chart above shows the 4 hour chart of the S&P 500 futures and it captures the rise in January 2018 and the subsequent plunge in the markets.

The S&P 500 is a good representation of the US economy as it comprises of 500 of the biggest and most influential companies in the US. Now that you have learned about the 4 stages of the market, it is easy for you to recognize it in the chart of the S&P 500 futures.

As you can see, the S&P 500 futures went through an entire cycle of the 4 stages during this short period of time. The S&P 500 had a base. Then it broke out of the base and entered into a stage 2 uptrend.

During this time it was great to buy stocks. Many stocks were just going higher and higher.

Of course, all bull runs come to an end and the market topped out in the short term. This was not a time to buy stocks. Traders and investors should stay away from buying stocks.

Eventually, the S&P 500 broke lower and started a nasty downtrend. Sometimes a downtrend can happen very fast. We can actually call it a plunge as everyone panicked and started to sell. Notice how the market goes down faster than it rises. On average, the stock market goes down 3 times faster than it rises.

What should you do when the market is in a Stage 4 downtrend?

Well...

Stay away or learn to short stocks.

The most important thing for you to remember is this...

Always follow the trend as the "trend is your friend".

If the stock is in an uptrend, you buy the stock.

If the stock is in a downtrend, you short the stock.

What Is An Uptrend

Let me now explain what is an uptrend.

I will show you how to know if your stock is in an uptrend or not.

An uptrend is made up of:

  • A series of higher highs and higher lows

When you think about it, it really makes sense. A stock that is in an uptrend will continue to make more new highs. Each time the stock rises, it will supersede a previous high. Each time it corrects, the stock will drop but it will not go below a previous low.

I think all these may sound very complicated.

So let me illustrate this to you using the example of Michael.

Michael loves to swim as a kid. He will never miss an opportunity to dip in the pool. Soon, his parents realized that he could swim extremely fast and they encouraged him to enter swimming competitions.

Michael won his school's swimming competition and he was selected to represent his school. It turns out that Michael really had talents and soon he became the district winner. Michael was then selected to represent his district in the State Championship and he became the winner as well.

With extra training and attention from coaches, Michael went on to win the US Swimming Competition. Michael was selected to train under the national team and soon went around the world representing the USA. Eventually Michael was able to break many world records. He became the World Champion and the Olympic Champion.

Ok...question for you now.

Is Michael's Swimming career in an uptrend or downtrend?

Well, it pretty easy to see that Michael's career has been going from strength to strength. With each successive win, he overcame a previous high. He overcame a previous achievement to become a greater champion. From the school to the district level to the state level to national level and the world stage.

Sure there were setbacks here and there but it never stopped Michael from achieving greater heights.

Michael's career in Swimming is in an "uptrend".

If you have invested in Michael, your investment would have given you a huge return. 

Let's take a look at the diagram of a stock making an uptrend.

Notice the similarity between the stock and Michael's career?

If you buy a stock that is in an uptrend, it is like investing in a champion.

Notice also how the stock is making higher highs and higher lows? Each time the stock rises, it overcomes the previous high and goes higher. When it corrects, the stock does not drop that much. Instead the stock stops dropping before it reaches a previous low. Thus the stock is said to make a higher low than the previous low.

The path of a stock in an uptrend is an upward trajectory. Sometimes it looks like the stock moves from the lower left to the upper right. Or you could say that it is making a 45 degree angle upwards.

Buying a stock that is making new highs may sound risky. Most people want to buy low. But when you do trend trading, you have to follow the trend. If a stock is in an uptrend, then it makes sense to be bullish on the stock and find places where you can buy the stock.

Let me show you a real live example of how a stock in an uptrend has become one of the biggest champion in the stock market. The chart above is the weekly chart of Nvidia.

As most of us know, Nvidia is a company that is involved in graphic cards. The explosion of technology and laptops and stuff like bitcoin mining has help to propel Nvidia's stock price to the stratosphere.

The stock has been relatively flat in 2015.

We can say that NVDA was basing in its own weekly Stage 1 during that time. In late 2015, the stock started to move higher. This was the beginning of a weekly Stage 2 uptrend in the stock.

Notice how NVDA kept on making higher highs and higher lows in the stock chart?

The chart moved from lower left to the upper right.

Each time the stock surge higher, it was able to make a new high. Each time it corrected and rebound, it made a higher low. This is a characteristic of a champion stock. This is the Michael Phelps of the stock market.

The stock went from $24 to $240 from 2015 to 2018. That's a 10 bagger according to Peter Lynch the famed fund manager of Fidelity Magellan. 

Do you now see the power of trend trading?

Trading or investing in a stock that is in an uptrend is like investing in the next world record breaking champion.

What Is A Downtrend

After showing you what an uptrend in stocks is, let me now show you what is a downtrend.

Well...

A downtrend is just the opposite of an uptrend. If a stock is in a downtrend:

  • It is making lower highs and lower lows
  • It is moving from top left to lower right
  • It will look like it is going down a hill

When something rolls down a hill, its better to step aside and avoid it. Otherwise you might be flattened by it!

To make it easier for you to understand the concept of a downtrend, allow me to show you an example from the business world.

Once upon a time there lived a hard and durable mobile phone called Nokia 3310.

It dominated the market and everyone was playing Snake on it. Those monochrome screen without color was a favorite among many.

By the way, if you drop it on the floor, it doesn't crack under pressure.

Not like some of the smart phones we have today.

Anyway, we all know that Nokia eventually headed south because it was not able to compete with other brands. I'm not an expert in how Nokia met its fate but companies such as Apple, Samsung and other smartphone manufacturers begin to eat into its market share.

Each new tech and each new product that competitors came out with made Nokia go down one step lower.

What Nokia's business experienced is a "downtrend".

Today Nokia no longer dominates the mobile phone market. Any mention of Nokia only brings back fond memories of its 3310.

Let me ask you a question...

If you knew that Nokia's business was moving south, will you still want to invest in this company?

Of course not.

Let's take a look at what a stock in a downtrend looks like.

Well, surprise surprise!

The stock price looks just like the business life of Nokia!

When a stock is in a downtrend, the above image is what you will see in its stock chart.

The stock will top out by making a Stage 3. Usually the price action at the top is wide and whippy. There will be a big fluctuation in the stock price at the top. Therefore, it is not unusual for a stock to drop 5-10% in a single day. You can often see a big red bar at the top.

I have written about this in the article How To Spot A Top In Your Stocks Using The Angry Bird

After the stock tops out, it will start a Stage 4 downtrend. This is where the stock starts to move lower. Each time the stock drops, it goes below a previous low. A relief rally does not bring much relief at all as the rally will fizzle out. The rally will not be able to go above a previous high.

This is the characteristics of stocks that are weak and in a downtrend.

One piece of advise I want to give you and which I want you to remember is this:

"Never ever buy a stock that is in a downtrend".

If you invest in a stock that is in a bad downtrend, it will be like investing in the next Nokia. There is a reason why the stock price is going down. Business is not doing that well. Putting your money into these stocks will be throwing away money into the drain.

How To Determine If Your Stock Is In An Uptrend

I hope that the simple examples and explanation above about uptrends and downtrends has help you to understand trend trading better.

It is not only enough to know what is an uptrend or what is a downtrend.

You need to know how to determine whether your stock is in uptrend. You also need to know whether a potential stock you want to buy is in an uptrend.

Don't worry...

I will teach you some simple methods to know whether your stock or a stock you want to buy is in an uptrend or not.

If you only buy stocks that are in an uptrend...

Your odds of success will increase dramatically!

Now...realize this...if you want to be more profitable in the stock market, you need to trade with the trend. If you want to buy stocks, only touch stocks that are in a proven uptrend.

Therefore, we need a filter to tell us when a stock is in an uptrend and when they are not.

Introducing the moving averages...

The moving averages are some of the best trend following tools in the stock market. They are free to use with most charting software today. They are also very simple.

A moving average is the average of the price of the stock for a certain period of time.

So for example if we take the 50 day moving average, it will be the average price of the stock for the past 50 days. Each day the charting software will automatically update the average price of the stock for the past 50 days and plot it on the chart.

In the old days, traders used to do the calculation themselves and manually plot them on the graphs. It was a painstaking process that took a lot of time.

Today with just a simple laptop you can get the calculation done with just the click of a button.

When it comes to moving averages, there are various types of moving averages. There is the simple moving average and also the exponential moving averages. Perhaps there are plenty more out there as people develop them.

I like to keep things simple so I use the simple moving average.

There are 2 moving averages which I would like to bring to your attention. They are the:

  • 50 day moving average
  • 200 day moving average

These 2 moving averages are some of the most well known and widely followed moving averages in the world. Many investors and fund managers and also traders will look at where the stock is at in relation to these 2 moving averages.

The chart above shows the daily chart of the Dow Jones Industrial Average futures with the 50 MA and 200 MA.

This is the staple setting that I have in my charts.

The yellow line is the 200 MA. The blue line is the 50 MA and the red line is the 20 MA. By putting each moving average into different colors, we can easily see each moving average and where the Dow is at in relation to the particular MA.

Here is the summary of what each MA means:

  • The 200 MA represents the long term health of the stock
  • The 50 MA represents the mid term health of the stock
  • The 20 MA represents the short term health of the stock

Now, this information is worth a gold mine if you use it properly.

If a stock is above its 200 MA, that means it is healthy in the long term. If it is above its 50 MA, that means it is healthy in the mid term. And of course if it is above its 20 MA, that means that is is healthy in the short term.

But here's another little special ingredient that you need...

Make sure all the moving averages are rising.

What this means is you want to see your stock above its rising 20 MA, 50 MA and 200 MA.

The keyword here is "rising". A rising moving average hints of strength in the stock or index. If the moving average is flat it tells us that there is a lack of strength. Therefore, you want all 3 moving averages to be "rising".

Think about it...

A rising star, a rising worker in the company, a rising diplomat...you get the idea.

A powerful stock or index that is in a strong bullish uptrend will be above its rising 20 MA, rising 50 MA and rising 200 MA.

If you really want to catch a strong stock with potential big bullish moves, that is the recipe that you need.

Take a look at the daily chart of Dow Jones futures above again.

I'm sure you will notice that the Dow was above its rising 20 MA, rising 50 MA and rising 200 MA. What you are seeing in the chart is a picture of power and strength in the Dow for the most part of 2017 and early 2018.

For the most part of 2017, the Dow was staying above its rising 50 MA and 200 MA. This told us that the environment was very good to invest in US stocks for the mid term and long term. You will notice that there are times when the Dow will drop below the 20 MA. That is alright because you cannot expect the index to stay above the 20 MA all the time. With shorter moving averages, you need to give it room to wiggle.

But if you look carefully, you will notice that the Dow was staying above its rising 20 MA most of the time. During the periods it was above its rising 20 MA, the stock market exploded higher in the short term. This was very very conducive for bullish momentum players.

When you look at the Dow in late January 2018 to early February 2018, you will notice it had a big fall. This happens when a stock or index runs up too fast. Nothing goes up non stop in the market. If the index runs up too fast we call this a parabolic move up.

A parabolic move up will eventually have a very fast plunge down.

The Dow slashed through its 20 MA and also the 50 MA. After that, things started to be very choppy. The nice trending up period for the stock market is over. For the trend follower or trend trader, you want to stay away from these kind of situations.

How To Find The Best Stocks To Buy Using Trend Following

I think the previous section has already explained clearly to you that you should follow the trend and use the 20 MA, 50 MA and 200 MA as the tool to guide you.

In this section I want to reinforce the education by showing you more examples of how the 20 MA, 50 MA and 200 MA can help you to be on the right side of the trend.

  • If you want to invest in a stock, always make sure it is above its rising 50 MA and 200 MA

When a stock is above its rising 50 MA and 200 MA, that is the best time to find opportunities to invest. There is always some stock in the stock market that is above its rising 50 MA and 200 MA. Choose the best.

Ok...

So what if your favorite stock drops below the 50 MA or even the 200 MA?

Well, if you are serious about trend trading, then stay away from the stock. This guide is here to help you find the best trend trading candidates. We don't want to waste our time with subpar stocks.

Let me repeat the criteria to find a great stock to buy using trend following. Repetition is important as our minds quickly forget what we have just read. I want to drill it into your mind so its stays there.

  • Only buy stocks for trend trading when they are above the rising 50 MA and rising 200 MA

Let's take a look at some examples below so you know what I'm talking about.

After looking at the examples below, you will wonder why you ever played stocks that are trading below their 50 MA and 200 MA. There is an abundance of money to be made when you know what stocks to select.

The first example I want to show you is the chart of Apple.

Apple had a very bullish run up from early 2017 to mid 2017. What happened there?

Well, Apple started a new daily stage 2 uptrend after a period of consolidation. The stock went above its 20 MA, 50 MA and 200 MA. During this period where Apple was above its rising 50 MA and 200 MA, it was the perfect candidate for trend following.

Imagine if you had known how to filter out stocks that are trading above their 50 MA and 200 MA. You would no doubt have spotted Apple and proceeded to trend trade this stock.

ABBV is another stock that had a nice run up. The stock went up from about 70 to 114 in 6 months. That is quite an impressive feat for this stock.

What are the ingredients for the stock's rise?

Once again, the stock had the necessary ingredients for a nice trend trading candidate. Yes, ABBV was trading above its rising 50 MA and rising 200 MA.

Simple isn't it.

When it comes to the stock market, your approach should be simple and sweet. There is no need to makes things complicated. Only play stocks that are above their rising 50 MA and rising 200 MA.

This is the classic picture of strength.

It is true today. It works 100 years ago and it will work 1000 years from now on. That is why the Wall Street maxim "The trend is your friend" is evergreen.

Those who ponder upon this investment maxim and really practice it will benefit tremendously in their life. There is power in trend following.

Who doesn't know Amazon?

The company of the richest man in the world, Jeff Bezos has grown from strength to strength. This is reflected in the stock price of Amazon.

Amazon broke out above a consolidation by gapping up on heavy volume. Notice how Amazon's stock price stayed above the rising 50 MA and rising 200 MA.

The stock went up by more than $500 since October 2017. Jeff Bezos' net worth also increased by 50%. One of his believe is to put the needs of the customers first and this has richly rewarded Bezos.

As you begin to look at more and more stock market winners, you will eventually jump to one conclusion. You don't need to sweat a lot finding what that conclusion is because I have already done the hard work for you.

The simple truth about stock market champions is this:

Great stocks that go up nicely are always above their rising 50 MA and rising 200 MA. Period.

A Simple Trend Trading Strategy To Profit From The Stock Market

Now that you know what are the technical requirements of the biggest winners in the stock market, it is time to equip you with one simple trend trading or trend following strategy. 

That way, you will be able to take advantage of the knowledge and start to profit from the stock market. If I do not show you a trading strategy I would be leaving you hanging. You know the characteristics of stock market winners but you do not know where to enter.

Later as you become more and more knowledgeable in the stock market, you will be able to find your own trading strategy that helps you to capture the trend.

Ok, before we continue, I would like to tell you how you can make money when a stock is in an uptrend...

You make money by either:

  • Buying the dips in an uptrend or
  • Buying the breakouts

There are plenty of trading strategies that allow you to buy on the dips. Buying the dips is widely mentioned in the financial media. When the anchor in CNBC interviews a prominent trader or investor or analyst, you will often come across this phrase "buy on dips".

The other way to make money is to buy the breakouts. Since the stock is in an uptrend, it makes sense to buy the stock as it goes higher.

When a stock is in an uptrend you should not be fearful of buying a high priced stock. The reason is the stock still has quite a lot of room to go higher. Some people are afraid of buying a stock that has gone up a lot only to regret not buying it when they see the stock double in price.

I will show you a simple method or simple trading strategy on how to buy breakouts.

I call this simple trading strategy "Breakout Above A Consolidation".

the breakout above consolidation trading strategy

So what is a consolidation?

For those who are new to the stock market, you may find it a bit hard to understand the lingo of the investing world. No worries, with time you will be able to understand them easily.

A consolidation is just a period of time where the stock is trading sideways.

The sideways trading should not be erratic. It should be relatively tight and orderly.

The image above shows how a consolidation looks like. The stock will trade sideways nicely for awhile and then it will breakout. A trader or investor can buy the stock as it breaks out.

The good thing about a consolidation is it gives you a reference point where you can set a stop loss. A stop loss or cut loss is important because not all breakouts will work out well. Treat it as an insurance against further losses.

You can place the stop loss for the trade below the consolidation.

A strong stock will breakout and move higher without looking back. If the stock falls below the consolidation, then it is telling us that our judgment is wrong. It is better for us to admit that we are wrong and take a small loss rather than be proud and stubborn and lose more than what we intend.

Once again let me show you how the trade works with some real live examples...

By the end of these examples, you will realize that this trend trading strategy works for stocks in all markets around the world.

The first example above is the same chart of Amazon that I showed you earlier. Earlier I told you that you should seek to find stocks that are above their rising 50 MA and rising 200 MA. Well, Amazon is one of them.

A truly powerful stock, Amazon gap up on very heavy volume in late October 2017. Now, when a stock gaps up on heavy volume, this is a signal of buying interest. The price action plus unusual volume tells us that this stock is being accumulated by investors.

The gap up may be because of earnings. Once the company had a blowout earnings and favorable outlook for the future, institutions and fund managers begin to be interested in the stock. The unusual volume tells us that many investors are pouring their money into the stock.

As time goes by, Amazon continued to stay above its rising 50 MA and rising 200 MA. This is a picture of strength and it is now up to us to find the perfect spot to enter the stock.

When we enter a stock, we want to enter as it breaks higher. We also want to have a reference point where we can place a stop loss in case the breakout does not work.

In the case of Amazon, the stock traded sideways forming a consolidation pattern. You can draw a box over the consolidation area so that you can see the area clearly.

The moment a stock breaks above the consolidation box, you strike and buy the breakout. Traders and investors could have bought Amazon as it broke out above the box. Then they can place a stop loss below the lows of the consolidation.

See how easy it is to plan ahead when you draw a simple box over the consolidation. Simple is always the best.

Amazon did not disappoint investors and for the next few months it advanced rapidly. This is the power of trend trading. You catch the stock as it breaks out.

Sure, there will be times when the stock corrects but in a moment I will teach you how to take profits in this trend trading strategy.

The next stock that is quite similar to Amazon's stock chart construction is Arista Networks.

The stock gap up on heavy volume just like Amazon. When there is lots of volume it means there are lots of buying interest. Never ignore an unusual volume when a stock gaps up. It is one of the biggest hints that institutions and smart money are putting their money into the stock.

To learn more about the effect of unusual volume on a stock's movement do take some time to read the article below when you have time.

How Unusual Volume Ignites A Big Move In Stocks

Unusual volume are the footprints of smart money. So it is really important that you learn how to pay attention to them.

So ANET consolidated after it gap up. This gave traders and investors a great trend trading setup. Notice how the stock was above its rising 50 MA and also above its rising 200 MA. This is a picture of strength. When you combine the fact that there is heavy buying interest in the stock, this sets up a very bullish breakout pattern.

You can draw a box over the area of the consolidation. Traders can buy the stock when it breaks out of the consolidation and put a protective stop loss below the consolidation.

Ever since the breakout, the stock has gone up about $100.

Not bad for a simple trend trading strategy.

This simple trend trading strategy works with all kinds of stocks. As long as the trend for the stock is up, it is very likely that you will be able to find a setup.

The chart above shows how Bluebird Bio consolidated for about 2 months. During this period of consolidation, the stock was trading above its rising 50 MA and rising 200 MA. Even though the stock traded sideways, the rising moving averages were hinting to us that something good is about to happen to the stock price.

Sometimes a stock will breakout higher from the consolidation when the rising 50 MA gets very near to the stock price. So if you see your stock consolidating and the rising 50 MA is about to touch your stock, get ready for a breakout.

Eventually Bluebird broke out of the consolidation it formed. After the breakout, the stock went from around $140 to $220. That's an impressive $60 bullish run for the stock.

Trend Trading Also Works In Other Stock Markets Around The World

Does trend trading work for stocks outside of the United States?

Well, yes of course...

This simple trend trading strategy that I show you works in any stock market in the world. It does not matter whether the stock is in the Hong Kong stock market, the Japanese stock market, the Malaysian stock market, the Singapore stock market, the Russian stock market, the French stock market or the London Stock Exchange.

As long as the stock is traded by humans, you can utilize trend trading to capture profits in the stock. Let's take a look at 2 examples of foreign stocks below.

The chart above shows the daily chart of Pentamaster which is a Malaysian stock.

For those of you who do not know where Malaysia is, it is the country north of Singapore with twin towers. You might have seen the Petronas Twin Towers in some article about the tallest buildings in the world.

Yes they do have a stock market in Malaysia.

Pentamaster is one of the big winners in the Malaysian stock market. As you can see from its chart above, the stock was trading above its rising 50 MA and rising 200 MA. This is a picture of strength. Even stocks in a foreign country exhibit the same winning characteristics that you can find in the US stock market.

Pentamaster consolidated for a while and then it broke out. This was a good time for traders to step into the stock. You buy the stock as it breaks out of the consolidation box and put a stop loss below the consolidation.

Look how nice the bullish run up in Pentamaster was. Remember its always a good idea to only play stocks that are above their rising 50 MA and 200 MA for trend trading.

In fact, if you only play stocks that are above their rising 50 MA and rising 200 MA from now on, you will be more successful in your investments.

The next example I'm going to show you is a stock across the pond. Easy Jet is an airline stock listed in the United Kingdom. If you have been to the terminals in the United Kingdom or across Europe, you would have seen the symbol EZY flashing on the notice boards. Those are planes operated by Easy Jet. Easy Jet makes it easy to hop around Europe on a budget. 

Once again, let us look at where the stock is at in relation to its moving average before it shot up.

Notice how Easy Jet's stock price was above its rising 50 MA and rising 200 MA. Although the 50 MA meandered around the price during the consolidation, the stock was already above its rising 50 MA when it broke out of the consolidation.

The breakout and run up may not be as superb as the other stocks that I showed you above but the trend trading strategy still works very well for traders in this stock.

When Does An Uptrend End

I have already given you a simple trend trading strategy that works. You now know how to enter a stock for trend trading. You even know where to put a stop loss. But you also need to know when you should take profits off the table.

Otherwise you will have a head but no tails. You want to have a complete package when it comes to trading the stock market. That is proper trader management.

The problem with many people is sometimes they know how to enter a stock. But they do not have a good system to tell them when they should exit.

Before I show you how to take profits off the table, let me show you how to know when an uptrend in your stock ends.

So how do you know when an uptrend ends?

There is no one size fits all answer to this question. It all comes with experience. However, there are a few ways to spot the end of the trend. I list them below and will give you a short explanation of each.

Basically a stock's uptrend can end...

  • When a stock breaks an uptrend line
  • When the stock goes below its 50 MA
  • When a stock fails to make a higher high and starts to make a higher low

Let us now go into a little bit more detail into each one.

For a more in depth look into stock tops, read...

How To Spot A Top In Stocks

When A Stock Breaks An Uptrend Line

A trend line is very important in the world of trend following. What is a trend line? You can learn a bit more about trend lines by visiting the article below.

How To Draw A Trendline And Use It To Analyze Stocks

Basically, a trend line connects the lows of the stock. You can draw a trend line by connecting as many lows as possible. The more lows it connects, the better the trend line will be.

There are 2 significant warnings if a stock breaks its uptrend line:

  1. The stock may soon experience a slowing bullish momentum
  2. The current trend is about to end

It is important for you as a trend trader to know that just because a stock breaks its uptrend line, it does not mean the stock will crash. Sometimes it just means that the stock may be trading sideways for awhile.

When the stock breaks an uptrend line, it is also telling us that the nice good easy time to make money in the stock is probably over. Therefore, a trader should always be cautious when their stock breaks an uptrend line.

The chart above shows the daily chart of the Dow Futures.

I have drawn 3 uptrend lines in the chart of the Dow. I draw the trend lines by connecting as many lows as possible. When you first get started, you might not know how to draw a trend line correctly. That's alright.

With practice and experience, you will know how to draw better trend lines.

When it comes to trend lines, you do not need to be perfect. Trend lines are subjective to a certain extent. Each trader will draw a trend line differently but they do not deviate too much. Most of the trend lines drawn by experienced traders will look more or less the same.

The first two uptrend lines in the chart of the Dow only showed a slowing down of bullish momentum. Notice how the Dow traded sideways both of the times it broke the uptrend line. This told us that momentum is just slowing down. The Dow is not in trouble. 

It is just taking a much needed rest before shooting higher. 

I'm sure by now some of you would have noticed the consolidation box in the Dow. I did not draw it in the chart but since you have learned about the simple trend trading strategy, you now know why the stock market exploded higher after it broke above the consolidation.

The 3rd time that Dow broke its uptrend line resulted in a massive plunge in the stock market. This time, the Dow failed to consolidate by trading sideways. it was not a rest. The plunge told us that the Dow was very tired climbing uphill. 

It did not have the power to sustain such a big move upwards anymore. Therefore, the Dow quickly gave up all the gains it had for the year.

The chart above tells us one thing:

Whenever a major index or a stock breaks its uptrend line, you should be cautious. It may or may not plunge but one should always be very careful and take the necessary actions to protect their capital.

Let's take a look at another example above. This is the daily chart of AEP which is a utility company.

A trader or investor who has learned about the importance of trend lines would have been able to spot the moments before the stock corrects. Notice how each time the stock breaks an uptrend line it goes lower.

The first and second time the stock broke an uptrend line, it corrected quite a lot. This is important for swing traders who were long the stock. Some swing traders who bought the stock might sell off their positions when the stock drops below an uptrend line.

Taking profits when your stock drops below an uptrend line can be a valid strategy to capture your profits. You can always enter again if the stock consolidates and breaks out higher.

The 3rd time that this stock broke below an uptrend line marked the beginning of a new downtrend. Breaking a trend line after all is one of the clues of a stock topping out. Notice how the stock quickly slashed through its 20 MA, 50 MA and even the 200 MA. 

Each subsequent violation of technical principles hinted of more drops in the stock.

Trend lines are very important. The above 2 examples show you how important they are to help you spot the end of a bullish move. Pay attention to trend lines and learn to draw them and they will help you navigate stocks better.

How To Take Profits Off The Table

I'm glad that I have shown you the effects of breaking an uptrend line. This will help to form the component of how to take profits off the table.

Knowing how to enter a stock is only half of the equation. If you know how to buy stocks but do not know how to sell stocks then you may end up giving back all the profits you make.

Learning to take profits are important. You may never catch all the profits but at least you have a solid plan to rake in the profits that you make.

So how do you take profits?

There are no one size fits all answer to this question. A lot depends on the individual stock and your experience. But here are a few tips to help you book profits:

  1. Take profits if it drops below an uptrend line
  2. Take profits if stock drops below the rising 50 MA
  3. Take profits if stock drops below the rising 20 MA
  4. Take profits if you are making a 1:2 risk reward in the stock

For simplicity's sake, let me just use the example of the Dow Jones Futures which I have shown you above.

Let's say you have learned about the "Breakout Above Consolidation" pattern after reading Dstockmarket.com's Beginner's Guide To Trend Trading. You notice that the Dow Futures is forming a consolidation. You buy the breakout and put a stop loss below the consolidation.

To your amazement, the Dow quickly shot up a lot. You are now making a lot of money.

You have also learned how to take profits and so you put it into practice. You check your risk reward ratio as Dow goes up and you realize you are now making a 1:2.5 risk reward ratio. Meaning, you risked $1000 and you are now making $2500. Therefore, you decide to sell some of your positions to book some profits.

As the Dow climbs higher, you are worried that it might collapse soon. But you hold on to the other positions until it breaks below the uptrend line that you have drawn. Once Dow broke below the uptrend line you have drawn, you sell some of your positions.

Later, you realize that Dow is now falling below its rising 20 MA. You sell a bit more of the remaining position. You still have a bit of the original position left but are just holding it because you think it might go back up.

However, Dow fails to make higher highs but instead it collapsed rapidly and suffered a panic selling. You tell yourself that you will sell the remaining positions if it drops below the 50 MA which is very near to your original purchase price.

The furious plunge quickly slashed through the 50 MA and you are out of the entire position.

Here are a few lessons from this simple example:

  • It is important to have a take profit plan
  • You will never catch the exact top
  • You should be selling on the way up not on the way down to book your profits
  • You do not need to sell everything at once
  • You can sell your positions piece by piece to capture the trend

If you have followed the steps on how to take profits you would not have suffered like many others do in the recent plunge. In fact you would have had a nice profit instead of giving it all up and then some more.

That my friends is the importance of having a plan!

Let's recap the take profits rules:

  1. Take profits if it drops below an uptrend line
  2. Take profits if stock drops below the rising 50 MA
  3. Take profits if stock drops below the rising 20 MA
  4. Take profits if you are making a 1:2 risk reward in the stock

These rules are simple but nevertheless they are powerful for a trend trader. Allow me to go a little bit more in depth on each one.

Take profits if it drops below an uptrend line

The many examples above have already shown you the dangers of a stock or index dropping below an uptrend line. Breaking an uptrend line does not automatically mean that your stock will crash. It can mean that the stock may be slowing down. But it can also mean that it will drop.

You never know.

So the best thing is to take some profits off the table. You can take 1/3 or even 1/2. Keep the rest in case the stock continues to go up.

This is trend trading.

Take profits if stock drops below the rising 50 MA

If a stock that is trending up drops below its 50 MA, then it can tell us that the health of the stock is not good in the mid term. It is better to use the 50 MA rule for stocks that are trending up slowly. A stock chugging up slowly and making a 45 degrees angle upwards slope should stay above their 50 MA.

Once it drops below the 50 MA, you should be very cautious and take some positions off the table.

The example above shows how the 50 MA can be used to take profits off the table. CHKP had a "Breakout Above Consolidation Setup" back in early 2017. It had a nice run up. Not the parabolic type but still an impressive run up of more than 20% in a few months.

The run up looks set to go up more but the stock eventually dropped below the 50 MA. This told trend traders that it was time to sell some of the positions. You see, we will never be able to catch the exact top of a stock's move. The 50 MA take profits rule will help us catch the meat of the move.

Sometimes the stock may bounce back up after dropping below the 50 MA. It happens. Even in the chart above, you can see how CHKP went back up to make another new highs before gapping down.

Well, traders who held on to some of the shares can sell the remaining shares as it went higher.

Trend trading is not about catching the exact highs. It is about catching the meat of the trend. Selling stocks on the way up is a good way to take profits.

Take profits if stock drops below the rising 20 MA

If you want to use the 20 MA as a profit taking tool, it is best to use it on a stock that has gone up in a parabolic way. Just like the example of the Dow Jones above, traders can take profit on the Dow futures when it drops below the 20 MA.

You will know if a stock's run up is parabolic by looking at the percentage gains. If the stock gains too much in a short period of time then the rise might not be sustainable. Therefore, it is always a good idea to take profits off the table when it drops below the 20 MA.

Take profits if you are making a 1:2 risk reward in the stock

This way of taking profits does not use any technical violations. Instead it uses common sense. A stock making a 1:2 risk reward is already giving quite a good return for your money.

Risking $1000 to make $2000 is good.

The problem is you never know if the stock's run up will stop or continue. Some people think they should make an all or none decision. But that should not be the case.

You can make partial decisions as your stock goes up. Selling 1/3 as your stock gives you a 1:2 R/R will enable you to bank some profits and ride the remaining position higher.

Sell Your Stock If It Hits Strong Resistance

Another place where you should sell your stock is when it hits an area of strong resistance. An area of strong resistance is difficult to overcome. It will also take some time before it can be overcome.

Therefore, your stock is likely to correct when it reaches that area. Instead of wasting your time waiting for it to overcome resistance, you should sell the stock and move on to the next best trend trading candidate.

But what exactly is an area of strong resistance?

Strong resistance is where there is lots of congestion in the past. There is a lot of price activity at the area and therefore it acts as a very strong ceiling.

The chart above shows the weekly chart of ACAD. Notice how each time ACAD tried to rally, it found resistance at the congestion area. This is a major resistance area and traders should take profits when it rallies to the resistance area.

To learn more about major resistance or the concept of support and resistance, be sure to read the articles below.

Support And Resistance In Stocks

Major Resistance And Minor Resistance

Try To Choose Stocks Making New Highs And With Less Resistance Overhead

I think the example above highlights to us the power of resistance areas to keep a stock from rising. In order to avoid this problem, I really suggest that you should choose stocks that:

  • Are making new highs
  • Have less resistance

First of all, a stock that is making new highs will rarely have enough serious resistance overhead. Therefore, the trend trader can easily ride the trend higher without much obstacle. Another benefit is stocks making new highs tend to go higher than we expect. This gives us a favorable risk to reward ratio.

There are plenty of stocks making new highs each and every day. 

Why not consider playing them?

The chart above is the daily chart of Amazon. Notice how the stock keep on rising and rising after it makes new highs. Well, part of the reason is because it is making new highs without much resistance overhead. Therefore, it can move higher very fast.

Lots of stocks that are making new highs will move even higher surprising many many people. Remember that stocks making new highs have little or no resistance overhead. Try and consider playing these stocks.

If you do not want to play stocks making new all time highs, consider playing stocks that have less resistance overhead. You can know whether a stock has less resistance overhead by looking at long term charts.

Usually the area of resistance will be so far away in the weekly charts that the stock will give you ample opportunity to ride it higher before it encounters some serious resistance.

7 Reasons Why Trend Trading Beats All Other Trading Strategies

How To Scan For Trend Trading Candidates 

Ok, so we now come to an important part of how to scan for trend trading candidates.

I will teach you now how to fish for trading candidates in the big sea of stocks. For every 10,000 stocks in the universe, there is probably 10 - 20 stocks that are perfect for trend trading.

You do not need to play 100 stocks. You do not even need to play 20 stocks. You do not even need 10 stocks, my friend.

All you need is a few stocks that are trending up nicely. That's all you need. The less stocks you focus on, the easier it is for you to monitor them.

To find stocks that are trending up nicely, go to www.finviz.com.

This is a free stock screener that will help you to find stocks that are trending up.

  1. Go to www.finviz.com
  2. Once you are on the site, click on the "Screener" tab.
  3. In the "Descriptive" section click on average volume and select more than 1 million
  4. Then click on "price" and select over $10
  5. Then click on the "Technical" section
  6. Then click the "50 day moving average" and select "above"
  7. Then click the "200 day moving average" and select "above"
  8. Then click on the TA tab to bring out the charts

You will get a list of stocks that are trending up and from there you can start to find "Breaking Above Consolidation" setups.

The result may turn out a few hundred stocks in a strong bull market so you might need to put in more filters like fundamental filters to find the best trading candidates.

If you want to scan for strong momentum stocks then click on the 20 day moving average and select "above". If you want to add in some fundamental criteria like earnings and sales growth you can input them in the "fundamental" sections. Just play around with them to get your ideal candidate.

Let me explain a bit about the criteria I have listed above to help you find trend trading candidates...

By choosing stocks that are above $10 and with an average volume of more than 1 million, we are finding stocks that have plenty of liquidity and not penny stocks. Choosing stocks that are above their 50 MA and 200 MA tells the screener to find stocks that are healthy mid term and long term.

There will be quite a lot of stocks that appear in the scan but you need to find the strongest trending up stocks and put perhaps 20-30 on your watchlist.

Then pick trend trading candidates from that list.

The Goal Of Trend Trading Is To Capture The Meat Of The Trend Not The Entire Trend

One final point to note is that the goal of trend trading is to capture the meat of the move.

Every approach to the financial markets has its advantages and disadvantages. You will never find a perfect approach in the market. When it comes to trend trading, your goal is not to catch the entire trend.

Your goal is to capture the majority of the move.

Let's say that the uptrend in a stock starts from $20 to $50. It will be foolish to think you can capture the entire $30 move. If you can capture $20 out of $30, that would have been a great achievement.

Perhaps you might enter at $25 and sell at $45.

It may not seem a lot when you compare it to the entire move. But if you catch a few stocks like this, your profits would have been substantial.

Conclusion

You now have learned about the basics of trend trading. I think you must be quite tired reading all these materials. What I have given you here are the building blocks of trend trading or trend following.

If you do not understand the materials the first time you read it, then its alright. Not many people can grasp such technical stuff on the first run. Read it again and again and try to understand more each time. You may also want to check out the Free Trading Course on my site.

I might turn this beginner's guide into a video lecture in the future. So stay tuned for more excellent stuff coming your way.

  • If you like this article, consider starting the Stock Market Course. It is free and jam packed with great information for newbies.
  • Want to have updates on the financial markets? Join my Telegram Channel. Dstockmarket.com Channel.
  • Help support this page and press the Facebook Like button below. Thanks!

Recent Articles

  1. Technical Analysis Lessons From OKA Corp Stock Chart

    Aug 17, 18 05:07 AM

    In this lesson we will take a look at the technical developments of OKA Corp's stock price and why it moved the way it did. We will also have a look at what might happen to OKA's stock price.

    Read More

  2. Technical Analysis Lessons From BMY Stock Chart

    Aug 16, 18 07:28 AM

    In this lesson, we will learn how and why BMY manage to bottom out and start a new uptrend.

    Read More

  3. Technical Analysis Lessons From Pentamaster's Stock Chart

    Aug 14, 18 08:19 AM

    In this lesson we will learn and examine why Pentamaster was able to recover all of its losses to start a new uptrend and achieve new highs.

    Read More

  4. Technical Analysis Of KLCI August 13 2018

    Aug 13, 18 05:56 AM

    The KLCI is currently at resistance territory after a nice big rally. I would consider a sideways trading a possible scenario at the moment.

    Read More

  5. Technical Analysis Lessons From AAPL's 15 Min Stock Chart

    Aug 13, 18 05:22 AM

    In this lesson, we will learn how AAPL's 15 Min stock chart formation help to send the stock higher for 2-3 days to give traders a nice swing trading opportunity.

    Read More

New! Comments

Have your say about what you just read! Leave me a comment in the box below.