After you were previously informed in detail about the definition of a trend, the development of trends, and the important aspects when displaying trends with the technical analysis, you now need to know how to efficiently and successfully use the collected information about a trend in practice. There are two general possibilities of how to react to an identified trend. By far, the smallest number of investors decide to react against the existing trend. Trading against the trend means for example selling instead of buying stocks when an obvious uptrend has occurred. Either they own these stocks already and close their position with selling or they perform short selling. Trading against the trend comes along with a higher level of risk, as it is empirically more likely for a trend to continue developing in the same direction than for it to end or to reverse. This holds chances on extraordinarily high profits if the trend really does turn around.
Most traders decide to trend following
The majority of investors decides differently and trend following once they have evolved. Trend Following is simply going with a trend and acting accordingly. Explained with the help of an example, this means that an investor buys stocks during an uptrend and evens out the own position or short sells stocks in the time of downturn. Mainly, Trend Following consists of placing buying or selling orders on the market in accordance to the identified trend. In general, it is a comparatively rewarding strategy to trend following. The statistical probability of a significant trend to continue amounts to more than 80 percent. The difficulty is to recognize the nearing end of a trend that is often followed by a – at least temporary – counter-reaction.
From identification to trend following
The most work that comes with trends is the traders’ preparatory work that must be done before Trend Following. Basically, there are three steps that must be taken in this context. Step 1 is using the Chart Method and paying close attention to the different stocks or derivatives that are of particular interest to the investor. Various analysis methods give investors the opportunity to recognize existing trends. In the 2nd step the investor has to decide whether or not the identified tendency is already a trend or only a temporary change in stock price that won’t last long. If in the investor’s opinion the tendency is a trend, it needs to be determined whether this trend has just begun or has already reached an advanced stage so that investing is not worthwhile. If the trend is still in the early phase, this 3rd step might lead to the actual Trend Following.
Newcomers prefer trend following
Trend following is a good strategy especially for newcomers, as the probability of generating profits is quite high. What Trend Following may look like in reality can easily be shown with an example: The investor John Doe is interested in buying stocks of an American company in the chemicals industry. The manual Chart Analysis, as well as the analysis programs, indicate that the company is in an uptrend, as the stock price has been increasing for longer than a week now. This can be considered a trend – at least a short-term trend. Since the company has good fundamental data, John Doe decides to follow the trend by buying 50 stocks to a price of 40 US Dollars each. During the next two weeks, the trend does indeed continue and the stock price enhances to 45 USD per share. Due to the good gain Mr. Doe decides to sell all his stocks and therefore generates a profit of 250 USD. This is a common example on how Trend Following works and can be used in practice.