Newer traders as well as veterans alike have been indoctrinated into the importance of “trend” when making buy and sell decisions. Traders that are strict about trading in the direction of the prevailing trend refer to themselves as “trend followers,” as they will wait for a trend to establish itself before making a trade. This strategy works fine when the market has a strong directional bias, however this isn’t always the case as the market can spend months without a trend.
When markets are range bound, in other words, when they vacillate back and forth without a clear direction, a trend following strategy will usually end up losing money. The premise of this type of strategy is that when a strong trend finally develops, a trader will stay with it until it reverses, and if the move is sizeable, the profits garnered by such a move should more than make up for the small loses taken in a choppy non-trending environment.
Before all the technological advances in trading such as electronic routing and the much maligned high frequency trading (HFT) machines, the markets tended to be much trendier, meaning that markets would persist in a solid direction for months rather than days. Back in the day, trades were done by hand written tickets on the floor of the stock exchanges and hand gesturing in the commodities pits .In addition information was disseminated at a much slower pace, which facilitated a stronger trend. This is why many of the highly successful traders back in the decades of the seventies and eighties implemented this type of strategy. That’s obviously changed now to the point where one key stroke can literally change the direction of the market.
If trend- following is a strategy that you implement, then it’s important that you have a concise set of rules whereby you clearly can define a trend. For instance, are you using a daily chart to define trend? Or perhaps it’s a 60- minute interval that defines trend for you. Next, how do you define a trend being established or confirmed? Is it a trend line? Or maybe it’s a sequence of higher highs and higher lows? Perhaps you use moving averages to gauge trend. Either way, it’s important to have a protocol in place in the trend following strategy that you practice.
As I mentioned earlier, many markets are not as trendy as they once were; however, there is still a handful of commodities, and currency futures markets that are somewhat trendy.
The grain markets are one of those trendier markets. The charts below illustrate how persistently directional these markets can be at times. Part of this trendiness has to do with the fundamental factors that drive these markets. These and most agricultural markets are driven by the basic concept of supply and demand in the physical commodity. So when there’s a shortage, price will go higher until the perception that the imbalance has begun to decrease. Conversely, when a bumper crop materializes, prices will collapse and stay down until the harvest season.
Another trendy market is the currency futures. We can see in the charts below that similar to the grain markets currencies also are very conducive to let profits run. The factors here are primarily that in the futures market all these currencies are traded exclusively against the US Dollar, and therefore when US runs deficits and keeps interest rates low, investors will sell the Dollar and buy higher interest rate currencies such as the Aussie or British pound. Also, major political changes can effect the value of the US Dollar.
In conclusion : Entering a trend early and identifying where the next turning point in the market will occur is key to making profits that have a good risk-to-reward ratio . These can be done by understanding the supply and demand curve, building a strategy around these core principles, and knowing which markets are the trendiest.
Until next time, I hope everyone has a great week.