TREND TRADING RULES FOR TRENDLINES

It may seem clear from the charting examples that the trendlines show where to buy to enter a trade and sell to exit; however, traders place their orders in a few different ways:
Entry Rules
• Buy when the price closes above the downtrend line (conservative).
• Buy when the intraday price penetrates the downtrend line (aggressive).
• Buy in an upward trend when prices decline to near the upward trendline.
Exit Rules
• Sell when the price closes below the upward trendline (conservative).
• Sell when the intraday price penetrates the upward trendline (aggressive).

Notice that the aggressive trader buys during the day when prices cross through the trendline. A more conservative trader will wait to see if the closing price is going to be above the trendline. Price action during the day can be very volatile and the direction of prices can change, and often does, from midday to the close. On the other hand, if important news reaches the market during the earlier trading hours, the first one that buys gains the most profit. You can only decide your style from practice. Start with the closing price as a measure of direction until you are confident that another way is better.

Getting Out of the Trade
When the upward trend is finished, prices will move down through the trendline. At that point you sell, closing out your trade, hopefully with a profit. However, not all trades are profitable. About two-thirds of all trend trades lose money, and yet trend trading is still a reliable, profitable way to trade.

Profits Through Persistence. The majority of times, a change of direction does not turn into a trend; however, when prices do continue in one direction, they produce good profits. Success is a matter of numbers. You can expect 6 to 7 out of 10 trend trades to be losses, some small, some a little larger. Of the 3 or 4 good trades you can expect one small profit, two medium-size profits, and one large profit. On average, a profitable trend trade should be about 2.5 times the size of a loss. With enough trades, that should result in a net profit in your trading account.
As an example, say we lose $100 on each of the 6 losing trades, for a total loss of $600. On the four profitable trades we get an average of $250 per trade for a total profit of $1,000. The individual profits are most likely $100, $200, $200, and $500. That’s a $400 gross profit less some slippage for entering and exiting and commissions on 10 trades. If instead of 6 losses there were 7 losses and 3 profits, we would net only $50. Expect the real results to be somewhere in between $50 and $400.


The Fat Tail
Trend trading is successful because losses are kept small and profits are allowed to grow. That technique is called conservation of capital. What makes trend trading profitable in the long run is the unusually large number of big profits compared to what is expected in a normal distribution. For example, in a normal distribution of 1000 coin tosses, half of them would be single runs of heads or tails. Half of those, 25 percent, would be a sequence of either two heads or two tails. Half of the remaining, 12.5 percent, would be sequences of three in a row, and so on. Therefore, in 1,000 coin tosses you can expect only one run of 10 heads or tails in a row.
Apply that to prices. In 1,000 days of trading (about four years) you would expect only one time that prices would go up or down 10 days in a row. However, that happens much more often than once; therefore, price movement is not normally distributed, and not random. It has a fat tail distribution. There are fewer days where prices turn from up to down, or down to up, and more longer runs. That’s what makes trend trading profitable.