Trend trading: Definition, indicators, and strategy

Buy low, sell high is investing 101. But how do professional traders decide when to buy and sell assets? Enter trend trading, also known as trend following. Trend trading is an investment strategy based on stock price patterns – and hopefully profit from them.

What is trend trading?

While there are many different ways traders analyze the stock market to inform their investment decisions, trend trading tracks specific, individual stock price performance. 

Trend traders look for price patterns that indicate which stocks are likely to keep rising over time vs. ones that might be headed downward. These trends help them decide when to enter or exit trading (more on that below) of a given stock and try to ride the trend for as long as possible. 

Types of trends

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There are three main types of trends that traders look at.  

1. Uptrends

An uptrend is when an asset's value consistently grows over time, demonstrating higher peaks and valleys. If a company's stock climbs every month – and any dips are still higher than before – it’s considered an uptrend. 

Some traders use uptrends as an indicator to sell or trade assets to make a profit. Uptrends may also suggest a bullish market, but not always. 

2. Downtrends

Downtrends show consistent declines in asset prices. Lower highs and lower lows mark these trends, reflecting bearish market conditions. Traders often use downtrends to profit from falling prices.

3. Sideways trends

Also called horizontal trends, sideways trends occur when asset prices move within a narrow range. These trends lack clear direction and experience frequent price reversals. Traders often avoid sideways trends because they’re unpredictable.

Why choose trend trading over other strategies?

Like any investment, trend trading involves risk, and there’s no one method that guarantees success (or we’d all be rich!). But there are a few reasons investors and traders might choose trend trading over other tactics:

1. Streamlined decision-making

Because it focuses on longer-term vs. short-term patterns, trend trading takes some of the mystery out of decision-making. You’re working with more established data trends and potentially fewer of the complexities that come with short-term fluctuations.

2. Enhanced profit potential

Trend trading involves trying to ride trends to reap maximum rewards. If you can align with market forces (a big “if”!), you can achieve big gains over time. The longer you can hold assets that are growing, the more you stand to profit if you can sell right before the upward trend starts shifting downward. 

3. Technical tools may help mitigate risk

Sophisticated technical tools can offer deeper insights to help mitigate risk. Trend traders can use multiple data points to inform their analysis and decisions.  

Downsides and risks of trend trading

Unfortunately, trend trading isn't an investing panacea. Trend reversals and whipsaw movements – sudden changes in stock prices and/or market fluctuations – can cause unexpected trend changes (and losses for traders). These movements can lead to false signals and interfere with trading decisions.  

What we can learn from trend trading

Trend trading is a valuable tool many professional investors and traders use to try to predict – and profit from – market momentum. But you don’t have to be an expert to benefit from trend following. Understanding the basic concept of trend trading and following market trends can help anyone improve financial literacy.

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