“The trend is your friend until the end when it bends.” – Ed Seykota

Trend following is a trading strategy that seeks to identify a trend (which is a general price direction of a market or security) and then follow that trend to take a favorable position. Trend following or trend trading is a commonly used intraday trading strategy.

How does trend trading work?

As mentioned earlier, a trend is an upward or downward movement in the price of a security for a certain period.

The key is to identify the trend right.

For instance, a stock that was INR 100 on 19^th June, INR 117 on 25^th June, and INR 125 on July 1 is said to be in an upward or bullish trend.

However, if the price moves in both directions within a range, it is not in a trending phase, but in a consolidation phase. Traders follow trends and hold on to positions until they believe the trend has ended.

The rule is simple:

For an uptrend and long position, one needs to place the stop loss below a swing low that has occurred before entry or below another support level.

For a downtrend and short position, one needs to place the stop loss above a prior swing high or above another resistance level.

A few things to keep in mind when trend following:

• Buy high, sell higher makes sense, although avoid overbought stocks that are ripe for a reversal.
• Follow the price objectively – look for higher highs and lower lows.
• Expose yourself to multiple markets and get used to identifying trends first.

Commonly used indicators for trend trading

Traders use a variety of indicators in isolation or combination to identify price trends and reversals.

For instance, some may use breakouts to figure out the start of a trend and use moving averages as criteria to enter the trade.

Momentum indicators, like Relative Strength Index (RSI), Average Directional Indicator (ADX), Moving Averages or MA (specially crossovers), and MACD are commonly used indicators for trend following/trend trading.

Trend lines and chart patterns are widely used to determine the pullback likelihood and confirm market trends or stock trends. Flags and triangles are also widely employed for evaluating the continuation of a trend. But more on this later!

Let us move on to an example.

Trend trading – An illustration using Moving Averages

Both simple (SMA) and exponential moving averages (EMA) as well as crossovers are used extensively in trend trading strategies.

How to identify trends:

An angled-up moving average shows an uptrend, and an angled-down MA shows a downtrend.

Observe in the image below that the price has stayed well above the 50-day simple moving average (50-SMA).

As the price crossed the SMA, it entered ranges in most cases. You can use mid-term MAs like these as a filter using the daily timeframe and aim to trade toward the MA in smaller time frames.

How to trade trends:

In simple terms, when the price crosses above the MA, it can be taken as a buy signal, and when the price crosses below the MA, it can be considered as a sell signal.

Trading using crossovers:

In the image below, we have plotted the longer-term 50-SMA and the short-term 10-SMA on a chart of TATA POWER.

A buy signal occurs when the 10-SMA crosses above the 50-SMA. A sell signal occurs when the 10-day crosses below the 10-day.

However, you must bear a few things in mind when using MA for trend trading. As the price of a stock is more volatile than its MA, this strategy may likely give more false signals.

Further, a fast MA may give false and early signals as it reacts too much to price movements and even make you exit early in case of a trend change. A slow MA may give you late signals.

If you’re willing to explore trend following, consider trying it on PHI 1. As shown above, PHI 1 is super easy to use even for a complete beginner and offers a plethora of advanced options for the expert trader.

Also, you can screen securities, create buckets, create charts and save them, and even experiment with strategies. Once you test your strategies, you can deploy them on the same all-in-one tool with the broker of your choice.

Let us carry the burden of mundane tasks while you focus on trading opportunities.

A breakout is defined as a stock price movement beyond a predetermined level of resistance or support with increased volume. Breakouts show the potential for the price to move in the breakout direction.

If there is a breakout to the upside, there is a high chance that the price will go higher, and similarly, if there is a breakout to the downside, the price will probably go further down.

The reason for the breakout to occur is that the stock’s price has been contained below a resistance level or above a support level for some time. When the breakout occurs at a high volume, the price is more likely to move in that direction.

Breakout trading can be used for intraday trading as well as short-term (one week to a month) and long-term (more than a month) trading using different time frame charts.

Several chart patterns can be used for breakout trading; however, the most commonly used pattern is the triangle pattern.

There are three types of triangle patterns: ascending, descending, and symmetrical triangle patterns (as shown below), which can be identified in the chart for trading.

Let’s discuss these patterns one by one.

Ascending triangle pattern:

This breakout pattern is a bullish formation and occurs when the stock price breaks the upper horizontal trend line with surging volume.

This upper horizontal trend line acts as a resistance. The lower trend line is inclined at an angle and rising diagonally.

The lower diagonally rising trend line shows the higher lows formed in each swing as the buyers slowly increase their bids.

Later, the buyers rush into the stock above the resistance price, triggering more buying as the uptrend continues. The upper trend line acting as resistance until now becomes the support for the stock.

Descending triangle pattern:

This breakout pattern is a bearish formation, which is an inverted version of the previously discussed ascending triangle.

The lows which are formed inside this pattern are almost the same, resulting in a horizontal trend line.

There is a decline in the upper trend line towards the apex, resulting in forming a triangle. The breakdown takes place when the price breaks the lower horizontal trend line, which was acting as a support. Now, this support line works as a resistance.

Symmetrical triangle pattern:

A symmetrical triangle is formed with the help of a diagonally falling upper trend line and a diagonally rising lower trend line.

As the price moves toward the apex, it breaks the upper trend line and uptrend with rising prices or breaks the lower trend line and downtrend with falling prices.

How to use triangle patterns for breakout trading

The steps which are involved in breakout trading using triangle patterns are common to all three patterns discussed:

1. Look for stocks which are trading in a range for sometime, so that this setup can be applied easily.

2. Draw the trend line joining the high and low prices of the stock.

3. An ascending, descending or symmetrical triangle pattern should form after joining these points.

4. More consolidation happening at the triangle’s apex shows that it may give a good breakout.

5. In an ascending triangle chart pattern, a trader should enter a long position after the confirmation, which is given by a green candle above the resistance line. Also, the green candle should show good volume (can be determined using a volume indicator).

The stop loss should be kept at the lowest point of the same green candle. The target should be an amount equivalent to the broadest section of the triangle.

In the descending triangle chart pattern, the trader should enter a short position once a red candle breaks the support line. Stop-loss should be kept at the high point of this candle.

The difference between the entry point and the vertical distance between the two trend lines should be the target price.

In the symmetrical triangle chart pattern, a bullish or bearish trend depends on whether the breakdown is happening from the upper or lower trend line. The stop loss is generally kept just below the breakout point.

What are the limitations of breakout trading?

Every strategy comes with limitations, and so does breakout trading.

1.False breakouts

When a stock is trading in a range, there are very high chances of false breakouts. A false breakout occurs when the price breaks the support or resistance, but then comes back within the previous range.

The problem of false breakouts can be tackled by avoiding entry immediately after the price breaks the support or resistance. A trader should wait till the candle closes (confirming the breakout’s strength) and then make an entry.

2. Corrections

Sometimes, after giving a breakout, the price increases sharply. The trader is pleased to see this; however, the price again comes back closer to the entry point in the next few seconds or minutes.

The trader gets confused by this scenario with a false breakout and exits the trade with a small profit. However, the price corrects and starts moving back in the breakout direction.

Key takeaways from this Breakout trading guide

Breakout trading seems to be a straightforward trading strategy to execute, but there are few limitations to using this method, such as false breakouts and corrections to breakout points. With the right practice and tools, you can master breakout trading in no time!

About PHI 1 – The complete algo trading software

PHI 1 comes with 120+ indicators allowing you to screen securities and easily carry out charting to identify patterns. This can help you trade with confidence.

Not just that, it also helps save charts, create trading strategies, and test and deploy them.

Experience the power of automation in trading.

Many of us do not have the time to trade intraday or prefer not to do so. Swing trading may be an option for people who do not want to do day trading. Swing trading focuses on trading over a short-term period (say a few days to a week or even 1-2 months). Here, a trader holds positions for more than a day. Usually, the target profit in swing trading is 10 to 20%.

Swing traders mainly focus on stocks that are highly liquid and heavily traded on the exchanges and often swing between widely defined high and low points. This gives advantage to the trader to ride the wave in a particular direction and make a profit.

Let us see some Pros and Cons of Swing Trading.

Pros:

1. Low time commitment: Day trading can be hectic, especially when it requires the traders to actively participate during market hours. (You can solve this problem with automated trading. Read more.) In swing trading, a trader can keep their position open for over a day to a few weeks and does not need to be a full-time trader.

2. Flexibility: One of the most significant advantages of swing trading is that a swing trader can square off positions according to their convenience, whereas a day trader needs to square off their positions on the same day.

3. Profitability: Swing trading can be profitable with proper risk management.

Cons:

1. Exposure to overnight and weekend price gaps: This is the most significant disadvantage of swing trading. Suppose any negative news or poor quarterly earnings of a company emerge after the closing of the market or on the weekend, the swing trader cannot exit their position and may face substantial price gaps the next day or week.

The only way to minimize the risk linked with the price gaps is to trade with smaller quantities or use a tool like PHI 1 that allows you to automate your strategies, such that trades are executed when certain criteria are met.

2. Locking of Capital

An intraday trader has the advantage of buying and selling the stock many times, and thus, they can rotate their capital to earn good profits. However, in with swing traders, their capital gets locked into a single trade or a few trades and does not free up until the trades are exited

3. Unsuitable for Extreme Market Scenarios: In full-fledged bull and bear markets, swing trading can be tough. This is because markets are highly volatile and may not move as desired by the trader.

Now, let us understand the MACD Crossover, an efficient strategy for swing trading.

MACD CROSSOVER

Moving Average Convergence Divergence (MACD) is a trend-following momentum indicator that shows the relationship between two moving averages of a stock’s price. Primarily, the 26-period exponential moving average (EMA) is subtracted from the 12-period EMA to get MACD.

MACD=12 Period EMA – 26 Period EMA

After this simple calculation, we get the MACD line. Further, the nine-day EMA of the MACD is calculated, which is called the ‘signal line’.

MACD is presented using a histogram that plots the difference between the MACD line and the signal line. When the MACD line is above the signal line, the histogram will be on the top of MACD’s baseline.

If MACD is below its signal line, the histogram will also be below the MACD’s baseline. Swing traders use this histogram to analyze when the bullish or bearish momentum is huge.

We can interpret MACD indicators in many ways: crossovers, divergences, and rapid rises or falls. However, MACD crossover is one of the commonly used techniques for swing trading.

Let us understand this technique.

The Buy/Sell signal forms when the MACD line and signal line cross each other.

A bullish trend is indicated when the MACD line crosses above the signal line. This is the right time to enter a trade.

Later, when the MACD line touches the signal line and crosses below it, it is the ideal time to exit the position and book profits.

Let us illustrate how you can do this on PHI 1

Shown below is the chart of CIPLA Limited with a time frame of 1 day. The buy signal is generated when the MACD line (blue colour) crosses above the signal line (red colour). The trader may enter at this price.

In the later part of the chart, traders could exit the trade when the MACD line reverses and crosses below the signal line.

You can create this strategy without any code. PHI 1’s form-based code creator allows you to create this using a drop-down mechanism.

Check out our webinar on how to create a MACD strategy on PHI1.

Whether you are a day trader or swing trader, PHI 1 can help you elevate your trading. As an intraday trader, you need not stay stuck to your screen.

PHI 1 offers screeners, charts, strategy creators, testing, and deployment  – all within a single, unified platform.