Trend investing is the process of putting your money in stocks, industries or markets expected to boom consistently in the future. The idea is to ride the trend up until it’s the right time to jump off and exit that part of the market with major profits. But before you go investing in the hottest new stock, it’s important to do your homework. This article will explain trend investing as well as some best practices. We’ll also explore its advantages and potential drawbacks. So let’s begin by understanding what trend investing is all about.
What Is a Trend?
A trend defines the general direction that a stock price is moving in. So trend investing revolves around the idea that if the price of a particular stock has generally been going up for some time, you can expect the trend to continue.
But of course, the stock market is never that simple. Companies fail, competitors beat them out, government regulations put strains on entire industries and overall economic conditions may mean sharp drops in demand for certain goods.
So how can investors identify companies and industries that can rise and stay the course? There’s no magic wand that would illuminate where these are. But seasoned traders take a good look at trend analysis or technical analysis. It’s fueled by the thought that you can safely predict the future price of stocks by examining recent price movements.
Today, there are several tools and methods you can use to analyze the performance of a stock. These resources may help you unearth patterns that may give you clues about that stock’s future. This is the basis of trend investing.How to Identify Trends?
To find a potential short- or long-term trend, you need to take a deep dive into underlying factors of the stock market. Luckily for you, there are plenty of digital analytics tools that do the hard work for you. Online stock screeners, many of which are free, serve as great examples.
You can use these to filter the market for stocks in a specific industry, with a particular market capitalization or within a price range. But don’t stop there. Plenty of free online platforms, tools and apps give you free access to charts and graphs that track and analyze stock performance for you.
Traders also identity potential trends by analyzing indicators. These are statistical measures that may identify certain patterns in the stock market.Trend Investing Strategies
Below, we identify and explore some common indicators in the world of trend investing.
Rate of Change (ROC): This indicator explores the current price of a stock relative to its price at any previous point in the past. The formula is as follows:
ROC = 100 X (Y/Yx)
In this case, Y is the most recent closing price of a stock. “Yx” equals the price of the stock a specific number of days prior.Frequent traders and those seeking short-term trends may want to use a smaller value for Yx, while those looking for longer-term trends may want to widen the scope.
The idea here is that if the stock price has risen in the last 10 days, it’s safe to predict it will continue to rise at least for the short-term. But those looking for long-term trends may want to examine the stock’s 26- to 52-week track record.
Of course, this ultimately explores two different points in time. What about everything in between? Moving averages can give you a better glimpse into that.
Moving Averages Indicators: Trend investors or technical analysts pay close attention to a stock’s moving average. The simple moving average (SMA) of a security is basically the average price of a security over a specific time span. Let’s say that time span is 200 days. If the price of a stock rises or falls sharply in relation to its 200-day moving average, that could be an indicator the trend may continue.
Trading Patterns: This process involves seeking a pattern in price changes and setting your own parameters. Say you examine a stock price dropping to a low level, then hiking before dropping back down to the previous level. Trend investors call this a support level. Theoretically, this is a point where there is enough demand to keep that stock from dipping below that level. But if it falls farther, you may want to exit that stock.
Momentum Indicators: Identifying patterns in price movements is one thing. But it also helps to gauge the intensity of those movements in any direction. That’s when momentum indicators come in. Some traders measure momentum or the acceleration of a security’s price change using the relative strength index (RSI). It helps investors identify when securities are overbought or trading beyond their real value. and also helps them pinpoint which are oversold or trading less than their true value. Technical analysts use the RSI to invest in stocks trending with sharp upward momentum, and exiting when that stock begins to lose momentum.Drawbacks of Trend Investing
While traders have a wealth of resources and analytics tools to help them identify potential trends in the stock market to profit from, the name of the game is ultimately market timing. And there’s an entire a school of thought in the investing world that suggests this is useless. Efficient market theory, for example, suggests that everything there is to consider about a company is evident in the price of its stock shares, which will always trade at their fair value. Supporters of this theory would argue it’s useless to seek overvalued stocks, because they essentially don’t exist.
Plus, all indicators and tools used to fuel trend investing ultimately rely on past information. Technical analysis, the process by which investors seek trends, is driven by the idea that past information about the market can help you predict the future. But history doesn’t always repeat itself.The Takeaway
Many traders have made big wins in trend investing. Think of today’s largest and longest-running corporations. They weren’t always the juggernauts they are today. The investors who saw potential in these firms at the right time reaped major returns. But it’s not about blind luck and throwing your money at today’s next big thing. Succeeding at trend investing involves careful planning, analysis and patience. Make sure you use all the tools at your disposal and always diversify your investments to hedge against any considerable risk.Tips on Trend Investing
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