From the August 01, 2010 issue of Futures Magazine • Subscribe!

How to find stock market trends

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Trade examples

On June 22, 2009, Goldman Sachs (GS) set a low of $137.01, the black line on “High bounce” (above). The 100-day SMA is trending upward when 11 trading days later on July 8, price retests the previous significant low from June 22.

The following day, the stock price closes above the high of the previous price bar’s high that had established a new significant low while retesting the previous low point, signaling an entry at $143.21. Price rose from that point to a high of $193.60 on Oct. 14, 2009, for a potential gain of $50.39, or 35%, in as little as three months.

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Another example of this trade setup occurred on NYSE Euronext (NYX) on Dec. 16, 2008 (see “Slip slide,” above). Price rallied to set a significant high at $29.99 before declining while the 100-day SMA was trending downward.

On Jan. 6, 13 days later, NYX rallied back to test this high and the following day an entry was signaled when price closed below the previous price bar’s high at $27.93. NYX went on to decline to a low of $14.52 on March 6, where you could have covered the short for a potential gain of $13.41, or 48%, in almost two months.

An impressive move captured by this technique can be found in Google (GOOG) last summer (see “Searching for profits,” below). On June 22, 2009, price declined to a low at $401.89, while the 100-day SMA was trending upward.

Ten trading days later on July 7, price declined to test the previous low and two days later, on July 9, an entry was triggered at $410.39. GOOG goes on to trend as high as $629.41 on Jan. 4, 2010, before seriously declining, but not before offering a potential gain of $219.02, or 53%, in just five months.

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The final bell

By using a combination of a trend filter (the 100-day SMA), price patterns and price action, you can let the market dictate when a trend is ripe for the taking. This simple method does not rely on complex indicators that can prove unreliable over the long term. Also, you let price tell you when to enter using the close above the significant high/low bar to confirm the resumption of the trend vs. relying on an arbitrary price point.

Trend following is more synonymous with futures trading but can be particularly affective with equities, as there are many more liquid markets to choose from. Spend time scanning the stock market and you’ll find that there are many opportunities where you could use this method to make low-risk trades in stocks where a trend is firmly in place. As always, be sure to use sound risk control and employ stop orders to protect yourself from unexpected market shocks. Many successful trend followers will tell you that their entry methods are pretty common and solid risk management is what gives them their edge.

In time, you could find that trend trading offers the kind of huge returns that drew so many of us to the markets in the first place.

Billy Williams is a 20-year veteran trader specializing in momentum trading in both stocks and options. Read his market commentary at www.StockOptionSystem.com or his newsletter on ETF Trading at www.FinanceBanter.com.

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