|Before implementing a trading system you need to identify the market conditions. There are three possibilities: trending, trendless or highly volatile markets. Each is identified by a characteristic type of price action, and in this series of articles I will discuss each of these markets, first focusing on trending markets.|
|A trending market is identified by a substantial increase or decrease in price extended over a considerable period of time. It is characterized by sustained directional moves in price with occasional and short-lived corrections. An example of a trending market is shown in the chart below of Dell Computer Corporation [DELL].|
|A popular trading system to apply in trending markets is the moving average crossover system. Here you can see that the crossovers trigger effective buy and sell signals when the stock is in a strong trend.|
|Graphic provided by: www.bigcharts.c.|
|Almost all markets trend 20% of the time or less. The remainder of the time is spent in a directionless phase. In order to catch the big trend early, you must be willing to be in the market all the time.|
|Once you identify a trending market, you need to apply a trend following system. These systems catch the wave of a trend and ride it until it is exhausted. Most of these systems create profits on a small number of trades and have a relatively low percentage of wins. If you are using this type of system you should be aware that more often than not you will receive false signals and will have several losing trades. However, designed properly, a trend following system experiences small, albeit frequent, losses.|
|Trending systems are difficult to trade since they don't provide much in the way of psychological reinforcement. You will find more losing trades than winning ones and because of this you can experience significant drawdowns. However, on balance, you can earn huge profits when a long-term trend takes over.|
One popular trend following system is the moving average. You can use single, double or triple moving average systems and their derivates when you identify a trending market. The chart of DELL shows how you can apply moving average systems to a trending market.
In the next article I will discuss the application of appropriate trading systems in trendless markets.
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