When Up Is Good, and Down Is Out

One of my favorite strategies is to initiate a “trend” trade,” also called “core” or “position” trades. This category of trade can also be used as the primary methodology of active investors.

Why are trend trades my preferred form of trading and investing? Because when performed with a well-thought-out plan and executed properly, they deliver the biggest chunk of profits available in a stock’s up-move (think creamy center of an Oreo).  As well, once in a trend trade, our risk management is straightforward and requires little attention. Finally, for the best part, we keep our profits. We don’t give them back when the stock or ETF gets tired and slides south.

Here’s how trend trades work:

1) We locate a high-quality stock or ETF that is building a base or consolidation on a daily or weekly price chart. Long-term investors may prefer using a monthly chart.

2) When (if) that stock or ETF price climbs above the base or consolidation formation, we purchase shares.  Then we hold that position as long as price continues to move in an uptrend.  An uptrend forms on a chart when our asset price continues to make higher lows and higher highs. An uptrend can last for days, weeks, months, or even years.

3) When the uptrend ends—that is, when price falls and closes below the prior low price established on our chart—we take profits.

Let’s look at the weekly chart of the Select Sector SPDR Energy ETF (XLE), below. From July of 2012, to July of 2014, it offered up a dandy trend trade.

Select Sector SPDR Energy ETF (XLE).

 

 

XLE Weekly Chart Oct26

Created with TradeStation. © Trade Station Technologies, Inc.  All rights reserved.

As you may remember, the broad market declined into the fourth quarter of 2011, and most sectors and stocks followed suit. The market regained strength heading into 2012, however, and the Select Sector SPDR Energy ETF (XLE) joined in.

By April of 2012, traders and investors monitoring its weekly chart noted that the energy ETF carved a higher low and then continued to climb, a bullish sign and a good entry for a trend trade at ~$65.

Now, once we enter a trend trade, we can use the simplest form of risk management:  We note each pivot low point (blue lines) on our price chart, and make sure that each low that forms is equal to or higher than the previous low.  As long as the lows “behave” in this manner, we remain in the trade.

If (and when) however, our stock or ETF’s price closes below the prior low point, we pocket our profits. No questions asked. Why? Because when price makes a lower low, it means that the current uptrend is completed, and bears are taking control. Do I want to stick around and let a crowd of cranky bears eat up my profits? Not a chance. For the trend trader, a lower low means we’re out—gains safe and intact.

On the XLE chart, you can see that price rose sharply into the summer months of 2014, and the XLE touched an all-time high of $101.52 in June. By the first week of August, the bears emerged from their caves and sellers took the XLE to a pivot low of $94.49; the low was followed by a brief gasp of energy. Then, the XLE rolled over and closed below the just-mentioned August low in the second week of September. We are out at ~ $93 with a 43% gain. Sweet!

In the XLE example just discussed, I shared the most rudimentary requirements of trend trading with you. As you might imagine, traders and investors who make successful trend trades over and over again (it can be done!) understand how to select the best stocks and ETFs to trade, and how to identify good entry and exit points. (I’ll share those with you at a later date.)

Please know that our current market environment is setting up now to offer some terrific trend trading opportunities. If you decide to try your hand at trend trading, remember, “up is good, and down is out!”

Keep green on your screen,

Toni Turner

 

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