Markets have a tendency to spend most of their time range-bound, or simply moving sideways. When a major trend does occur in a market, however, they can potentially be very powerful. A major trend can last weeks, months or even years, and can offer significant profit potential for traders who are able to catch a large portion of the move.
Traders need not buy the bottom or sell the top, either. In fact, many successful traders simply focus on catching part of the move. Some might equate it to playing between the 30 and 70 yard lines on a football field. The key is knowing when a strong trend has developed, and when it may be coming to an end. Below are a few useful tools for trend identification that may help keep you on the path of least resistance:
Moving averages: Moving averages are a simple, yet powerful tool for spotting a market trend. If you are looking to catch the larger, longer-term trends, then the choice of moving average used should be longer. The type and length are a matter of preference. Some traders will simply look at a 50 day simple moving average. Others may use a crossover strategy, in which they wait for a cross of a shorter MA such as the 50 to go above or below a longer MA such as the 200. Whichever MA you decide to use, they can provide a simple means of determining market trend.
Higher highs and lower lows: Another way to potentially spot a market trend is to look for higher highs or lower lows. A market that is trending higher, for example, should show a pattern of making higher highs. A market that is trending lower, on the other hand, should show a pattern of making lower lows. Equally important is the highs and lows against the trend. That is to say that a market in a strong uptrend should also make lower lows on pullbacks. A market in a strong downtrend should make lower highs on pullbacks. Such chart patterns can be especially powerful when combined with other indicators such as moving averages or the Relative Strength Index.
Bigger charts: A trend seen on a five minute chart does not carry anywhere near as much weight as a chart that is based on daily, weekly or monthly price action. Shorter-term trends may not be sustainable, and are often nothing more than common market “noise.” A clear trend seen on the monthly, weekly or daily chart may be far more indicative of a sustainable directional move. Traders looking to catch bigger trends, therefore, should focus their efforts on the larger time frames.
Whatever tools you use to spot market trends, chart structure is key. Look for markets with strong chart structure that have not seen a parabolic move higher or lower, as such moves are often unsustainable. A good rule of thumb is to look for charts that have shown incrementally higher or lower prices. Slow and steady may be preferable to fast and sharp, as a slower move may be more sustainable.
Long-term, sustained market trends can potentially provide powerful trading opportunities, potentially yielding thousands or even tens of thousands of dollars per contract. Of course, trend trading is not that simple. Traders must not only spot a market trend, but must also monitor that trend for any signs of weakness or exhaustion. Proper risk management is also a must. Due to the volatile nature of markets, traders may have to be willing to use wide stops or wait out significant market corrections in order to capitalize on a large portion of a trend.
There is a substantial risk of loss in trading futures, options and forex. Past performance is not necessarily indicative of future results.