Price-trend trading is an accepted stock-trading strategy. In essence, you find stocks that are outperforming similar stocks in the market -- particularly equities that have done so over time. In practice, you identify the trend according to a number of different criteria, such as an equity's breakout from a trading range, strengthening moving averages, repeated and stronger price uptrends and shorter and weaker price pullbacks.
Look for stocks breaking above their trading ranges. All stocks will move up and down in price, most often -- about 70 percent of the time -- within a trading range. From the beginning of October 2011 through January 2012, for example, Amgen (symbol: AMGN) moved up and down in price nine times in significant multiday moves without ever breaking below $52 per share or above $59 per share; it was a stock momentarily stuck in a trading range. During the same period, Automatic Data Processing (Symbol: ADP) moved up and down four times, moving further above the previous highs and lows with each successive move; it was a stock consistently breaking out of its trading range. The trend-following trader would buy the breakout stock during this period and avoid buying the stuck stock. Charts and information useful for accessing stocks by trend-folllowing criteria are generally available in financial media such as "Investors Business Daily," a national financial daily.
Identify stocks with stronger price uptrends. Sometimes it helps to step back from detailed movements and look for the most significant moves. Of the four price moves in the ADP example, the third was little more than a brief pause that could be considered part of a larger, stronger upward move. In this perspective, the stock made three significant upward moves, first from about $39 to $42 per share, then from $41 to $45, and finally from $44 to $49 -- increases of about 7.7 percent, 9.8 percent and 11.4 percent. These successively stronger uptrends send a strong buy signal.
Identify stocks with weakening pullbacks, particularly pullbacks that are short-lived compared with uptrends. In the ADP example, the three strong uptrends had gains that averaged about 9.6 percent and in each instance lasted more than a month. The pullbacks averaged around 2 percent and lasted on average a little more than two weeks. The third pullback was weakest, dropping about a dollar and lasting less than two weeks.
Strengthening Moving Averages
Compare the 10-day simple moving average, or SMA, with the 30-day exponential moving average, or EMA, for the same stock. When the SMA rises above (or in chart terms, "crosses over") the EMA, this constitutes a buy signal. When the EMA crosses below, this constitutes a sell signal. The reasons for this are complex, as is the math involved in determining these averages, but the SMA-EMA charts themselves are easily compared and widely available in "Investors Business Daily," in the research section of the major online brokerages and, for a fee, online at the StockCharts website.
- Bollinger on Bollinger Bands: Method I — Volatility Breakout
- Investors: Momentun Indicators Can Flash False Signals
- Trend Following: Learn to Make Millions in Up or Down Markets; Michael W. Cove
- Ryan McVay/Photodisc/Getty Images