Profit from Stock Market Trend Following

Let’s take a look at how you can profit from trend following the index.

I always talk about how indices always go up in the long term.  If you look at the chart below, although it goes through ups and downs in the short and medium-term cycles, it always goes higher in the long term because of population growth and inflation.

So if you’re a long term investor, it makes sense to simply buy and hold the index for the long term using ETFs or dollar-cost averaging.

If you had held on to this ETF in the past 30 years, you would have gotten a total of 991% increase in capital.

But if you look at it from a medium-term viewpoint, it will tell a different story.

Take a look at the 5 year perspective in the chart below. During the great financial crisis in 2006-2011, the markets were very volatile. If you had employed a buy-and-hold method during this time, you would have wasted your time.

If you had bought it at approximately $11,500 in 2006, at the end of the 5 year period, there is only a slight increase.

So you can see that the buy-and-hold method only works for the very long term (>10 years)!

The golden rule to make money consistently during the short and medium-term is: ONLY INVEST WITH THE TREND

WHAT IS TREND FOLLOWING?

You can see in any market, it moves in cycles of trends.

There is an uptrend and downtrend.

Read more here: The Power of Stock Market Trends

If you want to make money in the short and medium-term, you must follow this principle. You only invest with the trend.

The trend is your friend.

You only buy when it’s on a clear uptrend and you never ever buy when it’s on a downtrend. On a downtrend, the statistical probability is that prices will go lower and lower.

Take a look at this chart below:

You can see that the market went through an uptrend, a downtrend, and back to an uptrend again.

If you simply invest with the trend, you will enter at the beginning of an uptrend and as it goes up, you’re profiting from the market.

The moment it reverses into a downtrend, you will have to exit at the beginning of the downtrend so you will not lose your profits as the market collapses.

Imagine if you had followed this strategy, would you have made a lot of money? You would have made a lot more money than the person who bought and held for 5 years!

So why doesn’t everyone do this?

Because the majority of people have no idea how to read trends!

See, the moment you learn how to identify a trend, you can make a lot more money than just buying and holding the stock and at the same time.

HOW TO IDENTIFY TRENDS:

IDENTIFY WITH MOVING AVERAGES

You can see from the chart here that I am using the 50 and 150 moving average: the blue and the green line.

Here’s how the moving average will help you with identifying the trends:

Always remember that on a downtrend, the 50 moving average is always below the 150 moving average. When the 150 moving average is above the 50 moving average, you never ever want to buy or be in the market holding a stock because it’s a guaranteed downtrend, and probability is that prices will always go down lower.

In a downtrend, both moving averages are also sloping down.

There are 2 criteria to know when the market reverses into an uptrend –

#1: The 2 moving averages must stop sloping down and must flatten and/or slope up

#2: The 50 moving average has to cross above the 150 moving average

The reverse is true for an uptrend going into a downtrend.

If you’re in the market when it’s in an uptrend, you have to know when you have to get out!

To know when the trend reverses into a downtrend –

#1: Both moving averages must stop sloping up and start to flatten and slope down

#2: The 50 moving average has to cross below the 150 moving average

The moment you see the crossover, and neither are sloping upwards, you have to sell before the downtrend commences.

It is that simple!

Take a look at the 5 year chart below:

Once you input the 50 and 150 moving averages, it becomes very clear when to enter and exit the market with the 2 criteria above.

Notice that we are not predicting where the market will go, we are simply following the trend.

With this method, you can get a total of 72.7% returns in 4 years. That is much better than holding 5 years and getting less than 2% return.

Now this is a very powerful method to profit by trend following but know that no technique is perfect.

The disadvantage of this method is that it is a lagging indicator and it is a little bit slow to react. This method does not get you out at the bottom and get you in at the top but it still makes you pretty decent profits.

Of course, if you do want to know the exact points to get in and out, you will have to read up and study my advanced stock investing strategy called Value Momentum Investing™.