Follow the Trends: Trend Trading and Breakouts

A lot of new traders ask me what I think is the best to begin a trading career, meaning what kind of analysis, tools, etc. Unfortunately, I could give that new trader a way to position themselves for success but at the end of the day, you must make the choices of which analysis and tools that you will utilize. However, for the purpose of getting started, we will go over trend following and breakout trading.

Have you ever heard the saying “the trend is your friend”? If not, commit this to memory because it can help save you and make you money over the long haul. The point of this saying is to remind us to not trade against the trend. A trend is when the price action of your investment is rising, falling or sideways. The way the price action moves creates trends. Strong upward trends lead to upward price actions while strong downtrends show up as a negative sloping price action on a chart. Furthermore, the simplest way to determine the trend of an investment is by looking at moving averages. Moving averages are an indicator on the chart that essentially shows the average price action over a specific period of time. The most popular moving averages are the 50 day and 200 day moving averages (however, you may adjust the number of days to any level you wish). An upward trending investment will see its 50 day above the 200 day and a down trending market will see the 200 day above the 50 day. Luckily, these moving averages also tell us when the overall trend is changing, giving us time to wind down positions and moving into the opposite trade. For example, say we are trading Apple Inc (AAPL) and currently the 50 day moving average is above the 200 day. After a string of down days we begin to see the 50 day moving average beginning to angle down and soon its crosses below the 200 day. This now means that Apple is in a “downtrend” but, be careful because the price action could easily revert. As long as the 50 day remains below the 200 day, the stock is in a downtrend and a short candidate.

Prof. Binary’s Trading Tip:

1. The trend is your friend.

2. Don’t jump on the running train (trend). Wait for a pullback to enter the market.

3. Take care of the momentum. A decreasing momentum might signalize the end of the trend. If you can’t spot a decreasing momentum on the charts you can use an indicator like the MACD or the RSI. Look out for divergence! (read more about the basics of technical analysis).

4. Take care of support and resistance zones. Don’t buy into resistance and don’t sell into support.

5. Be patient!

Another form of trading is called breakout trading. Breakout trading is when an investor places a trade on an investment that is up against its support or resistance areas and showing signs of breaking above or below their respective trend lines. Usually, when the price action breaks through its support or resistance, it is followed by a sharp rise or fall as the price action looks for a new trading range. Unfortunately, investors must watch out for false breakouts, which is when the price breaks through the trend line, only to fall or rise right back into the old trend. This could leave you with significant losses if you are ill prepared. If we are looking at a price action that is up against its resistance level, be on watch for a breakout. Conversely, we must also watch out for resistance holding its ground, sending the price closer to support levels. The best way to find breakout trades is by looking for investments that are trading at or near their support or resistance with big news attached. It is the news that drives the investment to breakout in either direction.

The bottom line here is that trend trading and breakouts can be a lucrative way to trade but you must protect yourself from any downside. Remember, follow the trend, do not place trades against the trend or you may be putting yourself in a position to lose. Breakouts need news to help push the price action above or below trend lines. All in all, education and knowing your risk tolerance will help you become a better trader no matter what style of trading that you do.