Whether you are looking at short-term trading or taking a longer-term approach, there is a famous saying amongst investors, "the trend is your friend". So what does this mean, and how can it impact your trading strategy?
Simple chart analysis
When looking back at historical price charts, you will notice up trends, downtrends and sideways trends. While it is easy to look back with hindsight, you will see that trends repeat themselves regularly. This is where the term "the trend is your friend" comes from because it is possible to ride the trend and sell when it changes.
Momentum is the key
While listed companies/advisers do as much as possible to stop information from being leaked to the market, this can be challenging. Looking back at historical price charts, you will notice that when a company approaches quarterly, half-yearly or yearly figures, the price can fluctuate ahead of the figures. This is caused by many different factors such as:-
Short-term traders
In relatively steady markets, you are likely to see the majority of price fluctuations before and just after the announcement of company results. Rather than investing their funds for the full 12 months into a particular stock, many traders will join the party just prior to what may be expected to be good results. This can create a degree of momentum which will attract other short-term traders, creating yet more momentum.
Managing expectations
As many companies will issue a trading statement before entering a closed period, before announcing results, this is a perfect way to manage market expectations. This can often create a buzz around a particular stock, with additional information sometimes leaking into the market ahead of official announcements. Expectations can also be impacted by other prominent companies in the same sector, indicating the underlying trend in business.
Top trend indicators
While there are many different trend indicators, you can use when studying charts, the most popular include:-
Moving average trend indicator
When looking at individual price movements on a daily basis, it can be challenging to get an idea of the underlying trend. Therefore, using average stock prices over different periods can indicate the short, medium and long-term trend. For example, many traders will use trend lines created using the nine-day, 38-day and 90-day average price. The nine-day trend line is calculated by adding the value of the nine previous days' closing prices and dividing by nine, with a similar method for the 38-day and 90-day average price.These can be extremely useful!
Relative strength index
Many traders use the relative strength index (RSI) trend to identify momentum and scenarios where a stock may be overbought or oversold. In simple terms, this is done by looking at the average gains or losses over a period, usually 14 days, to identify the number of positive and negative days for the security price. This figure is then translated into a percentage between zero and 100, indicating whether a stock may be overbought or oversold in the short term. Traditionally, a figure below 30 is considered oversold, while a figure above 70 is deemed to be overbought.
Taking a contrarian approach
Some investors take a “contrarian” approach to investment which means going against the trend in the hope that it will soon turn. This approach is often described as “catching a falling knife” because it can be difficult to identify when the trend will change. Potentially lucrative but not for the fainthearted!
Dealing charges impact profitability
If you’re looking to trade based upon share price trends, you could find yourself dealing reasonably frequently. Consequently, trade execution charges can often significantly impact your overall profitability. Here at GIS UK, we are continually investing in our trade execution services, attracting volume traders, allowing us to offer an extremely competitive charging structure.