Trend Following

Trend following is often viewed as a longer-term form of trading where you own a stock for months or sometimes years. You purchase a stock that is increasing in value on the basis that the uptrend will continue. Conversely, you sell a stock that is decreasing in value on the basis that the downtrend will continue. However, the phrase “trend following” is a slight misnomer because every trade where you make or lose money will trend, up or down, for at least some period of time. A day trader may ride a trend for 30 minutes. A swing trader may ride a trend for two days.

A value investor could also be a de facto trend follower. The value investor analyzes a company’s fundamentals. Then he makes a determination about whether the company’s stock is over or undervalued. If his research says the company is worth $100 per share and it is currently trading at $50 per share, he will buy. Then he will wait until the price of the stock intersects with his view of the value of the stock. Of course, when you see the movement of the stock from $50 to $100 that is basically an uptrend.

Regardless of whether you are a day trader, swing trader, trend follower, or value investor, you are going to ride a trend up or down. For our purposes this post, the longer-term time frame is what we will refer to as trend following. If you are playing the long side, meaning you are buying a stock you believe will rise in price, the chart of your trade should start at the bottom left corner of the chart and rise toward the upper right corner. If you are playing the short side, meaning you are selling a stock you believe will fall in price, the chart should start in the upper left corner and end in the lower right corner.

Example of an uptrend below:

Example of a downtrend below:

If you are long the stock, ideally you will want to buy early in the trend, perhaps purchase more shares as the price rises to increase the size of your position, and your profits, and sell when the trend has stopped. If you are short the stock, you reverse that process. Sell near the start of the downtrend and buy, or cover, when the trend stops.

This form of trading is used by many of the most successful traders and investors in the world. If you can find good trends in great stocks, you will want to ride them as long as possible. It is a proven way to make significant money in the markets.