Fundamentals of trend trading
Checklist for trading trends
In this lesson, we look at one technical indicator that’s popular with trend traders – Bollinger bands – as well as what you must have in place to approach trend trading with the best possible chance of success. We also offer some practical tips for getting started.
Trending markets vs. range-bound markets
Before you start trend trading, you need to understand the difference between trending markets and range-bound markets (also known as ‘choppy’ markets).
In a trending market, the price is generally moving in one direction. You’ll see that there may be instances where the price goes against the trend occasionally, but generally, the price is headed in a specific direction (generally, an uptrend or downtrend).
In a range-bound market, on the other hand, the price moves between a specific high and low point, without seeming to be able to break through either. The high point represents a major resistance level, and the low point represents a major support level. It’s a bit like a choppy sea, with waves going up and down within a narrow range. Ranging markets often precede or follow strong trends.
Trends are quite rare, and it’s more normal for prices to trade within a range. Recognising which phase the market is in is important because it influences both your trading strategy and risk management approach.
Did you know?
A support level is a level in an uptrend at which an asset's price tends to stop falling and may even reverse direction, moving back upward. A resistance level is a level in a downtrend at which an asset's price tends to stop rising and may reverse direction, moving back downward. Traders will often look for key support levels or resistance levels to figure out when a pullback has run its course and price is ready to resume in the direction of the prevailing trend.
What are Bollinger bands and what can they tell me?
Bollinger bands are a popular form of technical price indicator, invented by John Bollinger. They are made up of an upper and lower band, set either side of a simple moving average (SMA). Each band is plotted two standard deviations away from the simple moving average of the market, and they are capable of highlighting areas of support and resistance. Traders use Bollinger bands to help them assess market volatility. If the bands are wider, it means that a market is more volatile; while narrower bands mean that a market is more stable.
When the bands are contracted, volatility is low and there should be little movement of price in one direction. When you spot the bands starting to expand, it signals increasing volatility, which may mean a price movement in one direction – a trend – might form.
Bollinger bands can be useful indicators of a trend in a market. When plotted automatically by a trading platform (which you can do using IG Charts), Bollinger bands are very user-friendly and can add another dimension to chart analysis for a trader.
Remember, however, that Bollinger bands are a lagging indicator, so they don’t predict price patterns – they follow current market movements. This means that traders might not receive signals until the price movement is already underway. Read more about Bollinger bands and how to calculate and use them here.
Trend trading checklist
Before you start trading trends (or implement any trading strategy, for that matter), it’s important to be as prepared as possible. Remember, you can practice trading with a demo account before you start trading in live markets, using virtual funds without putting any real money at risk. Find out more about how to use a demo account here.
Here’s a checklist to prepare you to start trend trading:
Understand your trading style: Are you a day trader, swing trader, or longer-term trend trader? The tools and indicators you choose to use should match your trading timeline and risk appetite
Learn the basics: Start with the fundamentals of trend analysis and the technical indicators. Understand how price charts, support and resistance levels, and trendlines work
Set goals: What are you looking to achieve? Be as specific as possible. Record your goals and reference them regularly to keep you on track. This should be part of documenting your trading strategy and keeping a trading diary
Pick a market: Decide what you want to trade. While some trend traders might choose to focus on one specific market, others diversify their opportunities by spreading their positions over a range of markets – gaining exposure to more trends
Choose which tools and indicators you are going to use to identify trends: There are many available and trying to use all of them may leave you confused (plus be enormously time consuming). Pick a few key tools and indicators to focus on. Common choices for trend trading include price, moving averages, Average Directional Index (ADX) and Relative Strength Index (RSI), all covered earlier in this course
Implement risk management: Managing your risk is a crucial aspect of trend trading. Aside from knowing when to enter a trade, it’s just as important to know when to exit. To manage your risk, you can attach a stop-loss to a position to minimise losses if the trend ends and the market reverses
Actively look for trend trades using trend trading strategies: Try to identify trades using pullback trading and continuation patterns (triangles/wedges and flags/pennants)
Keep up to date: Trend traders need to stay abreast of any developments that could drive new trends, or cause countertrends – from breaking news to central bank policy announcements and political events
Look for support: Follow experienced traders and market analysts, team up with a buddy or join trading forums to learn about others’ experiences. Ask questions and access trading resources
Experiment in a safe environment: Once you’ve picked your tools and indicators, practice trend trading in a demo account and tweak your trading strategy as necessary
Be ready to adapt: Understand that you need to change your trading strategy depending on market conditions. What works in one market might not in another
Get started: Predicting the exact movements of a market is near impossible. Remember that trend trading doesn’t mean you need to find the absolute beginning of a trend – you simply have to identify the trend early enough to follow the main body of the market momentum. The best way to do this is by practising in a safe environment, so get started with trend trading in a demo account (without any real capital at risk). See what works or doesn’t and update your trading strategy accordingly
Helpful questions to ask
One of the key characteristics of successful traders is that they constantly review their trading strategies and look to improve on them. Here are a few helpful questions to ask yourself as you develop and implement a trend trading strategy:
Am I using helpful tools and indicators? It can be tempting to overload your chart with all the indicators available, but overcomplicating things might do more harm than good. Ensure you’re focusing only on the most useful tools and indicators for trading a trend
How will I decide when to enter and exit a trade? Often, traders will enter a trade (or ‘scale’ their existing trade by upping their position size) in a trending market when it experiences pullback. But that doesn’t mean you have to act on every pullback. You should only enter or exit a trade when the parameters align with your trading strategy. This takes discipline, but that’s one of the key characteristics of successful traders
How will I decide when to increase my trade? Again, it’s tempting to spot an opportunity to scale a trade and want to jump on it immediately. However, rather than adding units or increasing your position whenever you get excited about an opportunity, it’s wiser to follow a considered approach. Ensure you have identified the precise price conditions for adding to your position, as well as how much you will add each time. You’ll need to carefully monitor the trend and the likelihood of its continuation or reversal, and (in case we haven’t said this enough yet) stick to your trading strategy
Is the trend still my friend? There’s an old trade expression ‘the trend is your friend’, but that’s only true until it ends. You need to be ready to spot a change in the trend direction or momentum and have your strategy ready, knowing exactly when and how you will exit a trade
Lesson summary
In a trending market, the price generally moves in one direction, whereas in a range-bound market, the price moves between a specific high and low point, without seeming to be able to break through either
Trends are quite rare, and it’s more normal for prices to range. Recognising which phase the market is in is important – it will influence your choice of trading strategy and risk management approach
Bollinger bands are a popular form of technical price indicator that traders use to help them assess market volatility. If the bands are wider, it means that a market is more volatile, while narrower bands mean a market is more stable
Before you start trading trends, it’s important to be as prepared as possible. Following a checklist can help you ensure you have all the important steps in place
A key characteristic of successful traders is that they monitor and adapt their trading strategy as required. Make sure you reflect on your performance and adapt as needed
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