Master Futures Trading With Trend Indicators

In all of trading, perhaps the quickest option to make a whole lot of money is to latch onto a trend in a futures market and ride it. This approach has two catalysts. First, futures trading involves leverage, which implies you simply put up a small fraction of the worth of the contract when entering a trade. Second, when a market soars or swoons, a whole lot of money will be made quickly. In fact, that is the excellent news. The bad news is that things may go in the opposite direction, so strong risk control is a necessary element to successful futures trading. This piece is not going to get into the nitty-gritty of risk control and money management. Somewhat, it is going to make the case for identifying and trading in tune with the first trend of a given market.

Within the Starting

An extended time ago, in regards to the time personal computers got here into being, trend-following systems that were “all the time in”—i.e., holding either a protracted or short position in any respect times—were fairly popular and might be useful. Back then, a market could trend way before a whole lot of people caught onto what was occurring. Today, market information is so available and gets disseminated so quickly that simplistic trend following is just not necessarily a viable alternative as a standalone approach to trading.

Likewise, the various whipsaws and long stretches of non-trending price motion make a pure “all the time in” trend-following approach lower than optimal from a rate of return perspective. After which there’s all the time the emotional “wear and tear” that comes with taking a whole lot of losing whipsaw trades along the best way while waiting for just a few truly big winning trades to generate the majority of overall profits. Because of this, only a few traders still depend on “all the time in” trend-following methods.

Still, because it seems, there are strong advantages to using trend-following methods, particularly once they are used primarily as a filter. Applying a trend-following method as a filter can allow a trader to maintain his or her capital focused within the areas which have the best likelihood of maximizing returns.

Distinguishing a Trend Filter From a Trading Signal

The aim of any trend-following indicator is just to have the ability to objectively designate the present trend as up or down, or in some cases, possibly as trendless. There really is not any prediction built into any given trend-following indicator. A given method doesn’t tell us that the trend can be up (or down) tomorrow, only that it’s up (or down) as of immediately. So investors must still concentrate on the potential for whipsaws.

When viewed in this fashion, the act of designating a given security as being in an uptrend or a downtrend is different from generating a selected “buy” or “sell” signal. As such, simply because a trader designates the trend as “up” doesn’t necessarily imply that he ought to be holding a protracted position. It does, nevertheless, mean that he should not be holding a brief position. In other words, the first function of a trend-following filter is probably not telling you what to do, but telling you what to not do. 

Trend-Following Filters in Motion

Let’s take a look at one example of an easy trend-following filter within the futures markets. We are going to designate the trend as “up” if the next two conditions are met:

  1. The ten-day moving average is bigger than the 30-day moving average; and
  2. The most recent close is above the 200-day moving average.

If each conditions are met, then a trader in this instance would only consider taking a protracted trade and would completely eschew trading from the short side.

On the flip side, we’ll designate the trend as “down” if the next two conditions are met:

  1. The ten-day moving average is below the 30-day moving average; and
  2. The most recent close is below the 200-day moving average.

If each conditions are met, then a trader in this instance would only consider taking a brief trade and would completely eschew trading from the long side.

Figure 1 displays one example of a market using this filter. The chart presented is definitely an exchange-traded fund that emulates a futures market. Any such ETF can act as proxy for a given futures market since there are not any contract expirations as there are within the futures markets. 

Figure 1.

Image by Sabrina Jiang © Investopedia 2021

The primary filter indication marked on Figure 1 notes that the 10-day moving average is above the 30-day moving average and in addition that the closing price is above the 200-day moving average. At this point, the trend is designated as “up,” and until further notice, a trader can consider moving into a protracted position but should absolutely not consider moving into a brief position since this may mean “fighting the trend.”

The second indication (“No Trend; No Positions”) simply points out the shortage of an objective primary trend. At this point, the trader would wish to stand aside until a brand new trend is established.

The following recent trend is established once more to the upside just a few weeks later and lasts for roughly five months before the following “no trend” indication occurs. During this complete time, the trader would have been focused solely on the long side of the market. As all price dips during this time were relatively shallow and short-lived, traders who attempted to play the short side of the market during this time would have almost certainly ended up experiencing a string of losing trades. The trader who focused solely on the long side of the market based on an easy trend-following filter not only enjoyed the best likelihood of being profitable by virtue of specializing in the first trend, but additionally avoided the emotional and financial drain of any countertrend losing trades.

The Bottom Line

The “rules” utilized in our example will not be intended to comprise a whole trading system. The one purpose of those rules is to maintain a trader focused on the value direction that’s presently showing the best strength. In other words, trend filtering is barely one piece of the trading puzzle – albeit, a highly useful one. A trader using a filter just like the one in our example still needs to include specific buy and sell rules, must determine what number of contracts to purchase or sell short, must determine where to put stops, etc.

Nevertheless, in the long run, the trader who can focus his or her capital and a spotlight on strongly trending situations has greatly enhanced their odds of profiting within the futures markets over the long term.

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