Seasoned stock traders will tell you over and over again that if you want to succeed in stock investing, then you need to operate along with current stock market trends. In fact, many of them claim it’s the easiest way to make money with stocks.
Think of it as a big ocean wave. Think back to the last time you were at the beach and you waded into the water. Imagine hearing the sea gulls and the wave splashing against the sand. You’ve drifted far from the shore and now you want to go back. How is the easiest way to do this with the least amount of work?
The answer is simple. You lift your feet and swim along with each passing wave. When the current wave stops, you simply wait for the next one and repeat the process until you reach the shore.
This is the exact concept with riding stock market trends. When a strong trend hits the stock markets, the most painful thing you can do is try to go against it. The easiest thing to do is lift your feet and swim along with each wave. The very same concept is the one we used at the beach – only this time we are taking about market trends and learning to harness the power of them.
Why Follow Stock Market Trends?
New stock traders are forever asking about the latest and greatest stock market trading systems. They want to know all about the newest stock investing software package and of course, the automated stock trading systems. Yeah .. of course, the automatic systems .. good grief.
The problem with many of these systems is that we become too dependent on them. And the reason become too dependent on them is because we didn’t bother learning how to trade stocks in the first place. So the canned investing system becomes a crutch.
There is nothing wrong at all with using tools and software to help you make investments, but you are the one who should be making the decisions. And you should be the one telling the investing software what decisions to make. As long as you are clear on that – go for it – but first learn the basics of the stock market, ok?
The big reason for following stock market trends is they are usually reliable. I have read over and over again that when you trade with the trend, you have a 75% chance of being right. It wouldn’t surprise me if the probabilities were actually bigger than that.
Notice, not “75% chance of making money” or “75% chance of having a winning trade”. The reason for this is there are so many new traders out there that might make a trade which is initially a winner, but they fail to lock in their profits and then they let it turn into a loser. Poor trade management is a really bad thing.
The Mechanics Of Trend Following
A very legitimate question from new stock investors is how do they follow a stock’s trend exactly. This is a great question – it sounds simple, but it’s not as simple as you might think.
To begin with, you to use a good stock charting tool. Do worry yourself about this because there are dozens of free stock charting tools available online. You can also buy charting software which is very cool and extremely powerful. These software packages let you back test trading systems – if you want to design your own – and they do all sorts of other neat things.
The only catch with these software packages is you usually have to pay a monthly fee for the stock data feed. Some of the prices are very reasonable at around $20-25 per month, and some charge as much as $500 per month (for stuff like stock option volatility data, etc.).
After you find the charting tool you will use, then you start using trend following indicators. I like to use the 20 and 50 day moving averages on the stock chart. When those lines are layered properly – the 20 day MA above the 50 day MA – then you have a good trend.
There is other trend following indicators too – such as the MACD. I urge you to experiment and find the one or two that you like. Remember that less is more when it comes to stock chart indicators. Pick one or two and then leave the others alone. Too many indicators will only confuse you and cause you added stress.
Mapping Out Your Trend Strategies
After you have found a handful of stocks that you are interested in trading, and after you have found a stock charting tool, now you are ready to formulate your trading strategies.
Let me tell you from the start, there is no wrong strategy or right strategy. The fact is that there are wealthy stock traders from every single category of trading styles. The key is finding one that works best for you.
When it comes to trends, I like to follow a heavily trending stock and then wait for it to pause for a few days. Why? Because they just about always stop and rest on their way up to new price highs.
When they stop and rest, I watch them closely. When they resume their stock market trends that is when I like to buy. This is actually a fairly safe way to invest in stocks. And it’s even more of a solid bet whenever a surge in trading volume accompanies that resumption of the strong trending price.
How to Find Stocks Suitable for Strong Trends
A lot of you may wonder what kinds of stocks are most suitable for these big trend moves. This is also a great question.
First off, you need stocks that have room to grow. These means that most of your large cap blue chip stocks are not very good candidate for trend following. You actually want to find stocks that haven’t become bluechip yet – in other words, you want future bluechip.
This means you want stocks that have lower daily trading volume – perhaps under 500,000. And you want them to have low P/E ratios (perhaps 30 or lower). And of course, you want them to have very solid and healthy fundamentals – such as two straight years of solid earnings, good annual growth, etc.
Secondly, you want them to be from sectors that are desirable and that traders really like at the moment. If you have ever followed the stock market at all, then you should that different sectors become “hot” and usually drive the rest of the market. These are the sectors that you want to be in.
Concerns with Trend Following
As with everything else in life that seems too good to be true, there are also some pitfalls when it comes to investing in trending stocks.
For starters, this style of trading ties up your capital longer than any other stock trading style. So there will be situation where you buy this great promising stock and it just sits there for weeks and do nothing.
Then you will see another stock that looks good to you. You will start watching this new stock and then you see it make a move, but you can’t do anything about it because your money is tied up with your first stock.
Worse yet, over time you watch this new stock that you love take off and reach new heights of profits – and it is doing it without you. Yet you knew it was going to happen. This is what happens with traders who are trend riders – they watch other opportunities come and go and they can’t do anything.
If this is the investing style that you choose, just remember you will have situations like the one I described above – guaranteed. Make sure you are prepared for this scenario, but if you are not, it will drive you nuts – trust me on that.
Required Mindset for Stock Market Trends
You may not believe this, but this is probably the most important section of this entire article. You see, the act of investing and trading in stocks is very mental. So many people reject this notion and continue looking at as mechanical. Guess what? These people end up learning this fact the hard way.
An example of this concept at work is refusing to acknowledge when a stock price is plummeting right after they have reported record earnings. People refuse to sell the stock and cut losses like they should because the numbers just don’t support the price action. These unexplained events happen every day in the stock markets and if you don’t go along with them – you are doomed.
The biggest mental challenge with following stock market trends is that it takes lots of patience. As a trend rider, all facets of your system is slow. It sometimes takes forever to find stocks that match your criteria. And then it takes times for that big move to manifest.
In the meantime, while you are waiting for that great stock you bought to make its move, the stock markets around you are moving and shaking. You are watching other stocks take off and make thousands of dollars for other stock traders, but yours is just setting there – it can be extremely frustrating.
This is not all. You will probably have to go through several stocks before you find that one big winner you are looking for. You will have to cut losses on perhaps 9 or 10 other stocks before the winner comes along. I’ve heard many trend traders talk about that one stock that made their entire year.
Don’t get me wrong, there’s nothing at all wrong with trading trends. You just need to know what it’s like and determine if it suits your personality and psyche. Remember I said stock trading is mostly mental? You will most likely lose all your money if your trading style doesn’t match who you are.
Managing Your Trend Trades
I said that the last section was probably the most important, but this one is a close second. It is interesting how two different stock traders could buy the very same stock at the same exact time and yet one could make thousands from the trade and the other take a loss.
The reason this happens is how they manage the trade. It is said that professional stock investors could pick stocks by blindly throwing darts and still make more money than amateur traders. Managing your stock trades will determine the outcome of your success – there’s no way around that.
The easy way to earn money is not to try to pick the bottom or top out of a big stock move, it is by taking a profit out of the middle. Don’t try to pick the turning points of a stock – it is very risky. But greed is what makes us want the whole move – no stock trader is that good.
Trend traders typically manage their trades with wide trailing stops. If you use too tight of a stop loss, you’ll get “stopped out” too soon and potentially miss the big move you are looking for. Many traders will tighten their stops too much right after their stock has jumped a few points. This is a sign of frustration and maybe a sign that you are not cut out to be a trend trader.
If you want a rule of thumb, many investors who ride trends tell me that they always set a trailing stop at 50%. This means that no matter what kind of move the stock makes, they are willing to give back 50% of it to the market. That is a very wide stop loss. Would you willing to do this?
Hopefully, you now have a better idea about the power and usefulness of stock market trends. I have tried to share with you what the mindset of a typical trend trader would be. Regardless of what your ultimate trading style will be, you really need to understand the different approaches you have available. And never forget that every single one of them can be very profitable if you know how to use them properly.