“The trend is your friend.” That is a statement that has been circulating among commodity traders for a long time. It simply means that you should trade with the trend of the market to help increase your chances of success.
What is a Trend?
A trend basically means that prices are steadily moving higher or lower over a period of time. A rough example of an uptrend is if prices are moving steadily higher over time and the chart looks like it is rising at about a 45 degree angle.
It is considered a down trend if prices are declining over a period of time and the chart looks like it is decreasing at about a 45 degree angle.
The reasoning behind following the trend is that prices are more likely to continue in that same direction rather than reverse. You put the odds more in your favor by trading this way. Many professional money managers trade with a trend-following philosophy and many commodity trading systems are built around trend-following formulas. As with every trading strategy, there are risks involved in trading by any method.
The Turtles
Proof that trend following works can be found in the story of the Turtles. In 1984, a very successful futures trader named Richard Dennis had a bet with another trader William Eckhardt on whether he could give a group of individuals a simple set of trading rules that would make them successful traders. The trading rules consisted of a trend following system and simple money management skills. It turned out that the experiment was an amazing success and some of the students went on to pursue trading careers.
Tips on Following the Trend
You never know how high or low a market is going to move. Therefore, if you follow trends, you can catch some very profitable moves in the commodity markets.
There are two common ways to enter the markets when you spot a trend:
Buy on a pullback. If the market is in a clear uptrend, a good technique is to wait for the market to pullback before you go long in the market. Some simple strategies are to buy when the market goes down to touch a moving average or a clear trend line. Basically, any solid support level can be incorporated.
The theory is that support levels are often more likely to hold in uptrends and can be good buying opportunities. I like to use the 20 period moving average, strong trendlines and Fibonacci levels. It is even better to enter the market when more than one of these support levels cluster at or near the same price.
Many traders use this underlying strategy as their basis for trading. It can be very successful, but it doesn’t work all the time, which is true for all other methods. Make sure to use stop orders, but even these cannot eliminate all the risk.
Buy when the market makes new highs. You will likely not miss entering a trend this way. This is the hardest thing for many traders to do and that may be why it can be successful. This technique became popular with the Turtles, but it has evolved since and care needs to be taken when trading with this methodology.
Some traders have been using this as a counter-indicator; this means they take the opposite side of the trade on new highs or lows. In fact you will see some markets accelerate when new highs are made, but many times the market will reverse quickly after a new high is made.
This approach has become common, thus the strategy requires some patience and good risk control. The fact is that many of the breakouts will fail or at least have quick reversals. Many traders get shaken out of their trades and then the market resumes its breakout. I recommend doing a lot of research and back testing to understand this strategy and how best to trade it. Again, there is no guarantee that trend following will make for overall profitable trading. However, in my opinion it helps with the odds if the strategies are well tested and traded.
Final Thoughts
Remember that trends don’t last forever. You still have to control your risk and protect your profits. Sometimes catching a couple strong trends can make the year for a trader. You still must have patience to stay with the trend for as long as it lasts to maximize profits. Many traders don’t have the patience to withstand the ups and downs of a trend following strategy.
There is also the issue of a very strong trend ending very quickly and sharply. The news and technicals might still look good, but how do you know when to finally get out? The answer is that you don’t know for sure. But, the way to trade it is to have preset criteria to exit the trade. This could be a break of a trend line, a reversal of more than 10 percent or a technical reversal on the charts, etc. It is up to the individual trader, but protecting profits after a big run are critical to success.
Trend following strategies can be very rewarding, but it is important to be able to identify trends and have a good plan in place on how you will trade trends. Markets can trade sideways for a long time and have a number of false breakouts. This can be damaging for trend traders, but a disciplined trend trader can put the odds more in their favor.
Past performance is not necessarily indicative of future results
