A New Asset Class and the Repercussions
A brand new class of assets has emerged since Bitcoin hit the internet in 2009. Since then, we’ve seen the creation of an intriguing new phenomenon where anyone willing to try can start trading. To add to that, Forex trading initiated the move into social trading, where newbies learned from experienced traders. Now that movement is taking root with cryptocurrency trading, despite the exasperation of cryptocurrency regulators, who are feverishly trying to put the worm back in the can.
Once relegated to the most experienced Wall Street professionals, trading in general has increasingly taken on a more decentralized nature. Now, trading platforms and a stream of crypto influencers are raising the level of awareness around trend trading.
Definition of Trend Trading
Trend trading is an investment strategy where traders base their investment decisions on the analysis of a particular asset’s momentum.
This momentum means the value of the security is moving up or down. So a trend trader can buy a security when it’s upward trending after noting that movement. Conversely, they may want to sell when they observe a downward trend.
There are multiple ways of determining when is the right time to buy and sell with this type of strategy. We’ll get into that in just a bit. But first, it’s important to note that there’s another aspect to trend trading, outside of responding to charts. And it’s specifically relevant to crypto trading.
Trends or Market Manipulation?
With little to no regulations on the crypto market, the opportunities for manipulation are being tried and tested. On an epic scale. So, trading according to trends must also take this into consideration.
It’s no wonder that many crypto traders are constantly keeping abreast of the market news. Later in the article, we’ll look at what is behind some of the trends that traders are moving on. Because if the cryptocurrency market has taught us anything thus far, it’s that there are many influences that determine the value of a crypto asset.
During the last few years, trend trading has evolved to something more than watching for movement signals on charts. Now, crypto enthusiasts of all skill levels are trying to predict movements as well. Their news feeds offer plenty of fodder in this capacity. It’s essential that new traders have a good understanding of the basics of trend trading so they can make decisions based on data as opposed to emotions.
What are the Benefits of Trend Trading?
Whether you’re a seasoned Wall Street pro or a new crypto trader, the basic advantages to trend trading are the same:
- You have the opportunity to increase your win rate. Trend trading is a tool that you can use to try and make more profits.
- Your risk to reward ratio can be higher. Because you are analyzing movements and histories of a particular security, you may have a better chance of choosing the correct times to buy or sell. This makes more sense than buying in reaction to FOMO (fear of missing out) or FUD (fear, uncertainty and doubt).
- Trend trading provides a simple way to identify strong trends. This helps alleviate a less than perfect set of buy and sell rules. In essence, no trader can be 100% correct all the time, but this strategy may bring you closer.
- While it’s not a guarantee that all trades with this strategy will be winners, trend trading allows you to be less exact with entries and exits. That’s because when you identify a strong trend, you simply make the buy or sell then and there.
- Trend trading can cross over to almost any market, including futures, commodities, securities and now, new cryptocurrencies.
All trends eventually end. An uptrend will at some point become a downtrend. Usually, this happens when the security exhibits lower highs (LH) and lower lows (LL). The charts below help to visualize this.
What Causes Trends?
It’s important to know what’s behind all these trends that motivate traders to move. Many would agree that most trends are the result of one or more of the following:
- FOMO (Fear of Missing Out)
- FUD (Fear, Uncertainty, Doubt)
“Trends exist due to greed and fear in the markets. When there’s greed, you’ll get more buying pressure, which results in higher prices (an uptrend). When there’s fear, you’ll get more selling pressure, which results in lower prices (a downtrend).”
Is Trend Trading a New Phenomenon?
We’re now experiencing a rapidly growing influx of new traders to the market. This is mainly due to the emergence of social trading and the ‘wow’ factor of crypto, which hooks people in and offers financial independence, among other things.
But trend trading has been around for a long time. In fact, Jess Livermore carved out a reputation as the most famous trend trader in history, netting $100 million back in 1929 by selling before the crash.
During the 1980’s, Richard Dennis and Bill Eckhardt held an experiment in trend trading that effectively put the practice in the limelight. They put a group of newbie traders to the test, teaching them how to use their trend trading strategy and them letting them go.
They wanted to prove that by using their trend trading method, brand new traders could be as successful as the pros. The group of newbies was called the Turtle Traders, because of the Turtle trend trading strategy they were taught.
Incidentally, they wound up making over $100 million in profits. Richard Dennis, one of the founders of the Turtle Traders, raked in $400 million by applying his strategy to the futures market. Not surprisingly, the methods used by the Turtle Traders represent some of the fundamental tools of trend trading today.
The Basics of Trend Trading
The Turtle Traders generated trading signals by watching for breakouts among key moving averages. (We’ll go into detail on moving averages very soon.) These trade signals, created by analyzing securities charts, prompted them into action by either performing a buy or a sell. Back then as well as today, these analyses were generated in many different ways, including the use of Technical Indicators.
These represent a suite of analytical tools for trend traders. Technical indicators are mathematical calculations that are based on price, value and open interest of a security. A technical analyst can take these indicators into consideration when predicting price movements. Examples of technical indicators would include the Stochastic Oscillator and Moving Averages. Often, trend traders will use multiple indicators.
What these (and numerous other) methods do is allow for unemotional trading. Trend trading is based on movements and numbers without ever letting human feelings get in the way. In the crypto space, we’re seeing the proliferation of Bitcoin bots that trade automatically. Additionally, a key aspect to social trading is copy trading, which also focuses on automation. Making the most of the data tools we have helps traders make rational trading decisions.
What are Moving Averages?
Essentially, moving averages are technical indicators that use averages to smooth out the many ups and downs of a security price. They’re named moving because as time goes, the averages are constantly updating.
This is helpful for traders who want to look at the past price history. In itself, a moving average is not predictive in quality. It is the traders who analyze them to make their predictions based on these average data points over time.
By looking at moving averages, traders may see a signal that a security’s price has lost momentum. Or it may be experiencing a downtrend. In this case, the price is running below the moving average. On the other hand, when prices are above a moving average, that’s a signal indicating more bullish prices for that security.
Moving averages do not predict price movements. But they do tell you how the price is acting on average for a particular security over time. Thus, they represent a set of tools for trend traders to analyze the direction and strength of a certain trend.
The Simple Moving Average Explained
Let’s look at one common way of using moving averages in trend trading, called the Simple Moving Average. To calculate this moving average, we take the mean of a given set of values. These values are then plotted on a chart for analysis.
Example: If you wanted to look at a simple 5-day moving average, you would follow these steps:
- Determine the closing costs of each day
- Add those values
- Divide them by 5 (the number of days)
It would look something like this:
Moving Average Crossovers
Whereas a moving average is a line on its own, it can often be overlaid with other moving averages. A crossover occurs when two or more moving averages intersect on the chart.
For instance, say you have a short term moving average (5-day) and a long term moving average (100-day). When the short term moving average line crosses with the long term moving average, you have the crossover. That intersection is often an indication to buy or sell.
Trend Trading Considerations for Crypto
With the emergence of blockchain technology and hundreds of cryptocurrencies, we’re seeing many newcomers to the trading space. Also, traders that have worked in traditional markets are also coming into the crypto market. What we have is a new industry filled with high energy and a mix of professional experience and inexperienced traders.
Luckily, expert traders are active in the crypto trading environment now. They’re doing things like:
- Creating trading strategies that integrate traditional methods with digital assets.
- Making educational videos to help newcomers get up to speed.
- Explaining trading topics on social media and forums.
We have really only brushed on the potential of this exciting and complicated topic. Risk management steps would be a logical next step to study. But hopefully, this article will have given you a good start to learning about trend trading. Certainly, it’s important to offer crypto enthusiasts a way to out of simply reacting to news and FUD. Alternatively, this type of strategy helps to take the emotion out while maximizing the technical tools available to us today.