Getting involved in trend trading requires that you have discipline. You never want to trend trade–or in fact, do any kind of investing–on emotions. You don’t want to be a pawn of greed and fear like the masses of traders are. So, the way to take emotions out of the picture is to have a system in place that you know you will use before you begin trading.
One of the most often used trend trading systems out there is the GMMA, or the Guppy Multiple Moving Average. With the GMMA, the trader puts together two different groups of moving averages that have different time periods.
One of these groups is quite often used by traders with a short-term horizon. The number of days in their time horizon is, most of the time, one of the following: three, five, eight, 10, 12, or 15. For those who are involved with long-term investing as trend traders, they use time frames that consist of 30, 35, 40, 45, 50, or 60 days.
Traders use this relationship between these two different groups of moving averages for determining whether or not the outlook of the short-term traders squares with the long-term traders. It is thought that this cross-checking enables greater objectivity and, therefore, makes sure that the traders aren’t relying on their emotions to make their decisions.
Changing trends get identified by the point where the two different groups of moving averages intersect. A bullish trend means that the short-term MAs are above the long-term MAs, while of course the opposite is true in the event of a bearish trend: the short-term MAs are below those of the long-term MAs.
Trend traders may also use the Exponential Moving Average, or EMA. With this tool, the trader places more weight for decision making on the latest moving average, although he pays attention to all of them within his time horizon. So EMA also gets called the “exponentially weighted moving average”. An EMA responds faster to recent price changes than does a simple MA. The 12-day and 26-day EMAs are the most widely used short-term averages; they get used for producing indicators such as the MACD (moving average convergence divergence) and the PPO (percentage price oscillator). Long-term trend traders would look to the 50-day and 200-day EMAs for their signals.
For trend trading, there also needs to be risk management in place in the system. The simplest way of managing risk is to use the 2% rule. This very simply means that you as a trader take the value of your investment account or portfolio and calculate what 2% of it is. This is always the largest amount that you will invest into trend trading at any given time. The 2% rule keeps you from losing your shirt and your house with your investments. If you make money, you add that to your total and can risk more and more. But if you lose money, you don’t lose that much compared to your total money, plus you keep diminishing your total investment until you start earning more again.
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