Utilize this trend strategy to capture profits in high momentum stocks. This strategy utilizes an Average True Range (ATR) based indicator that provides buy and sell signals and also acts as a trailing stop loss. The systematic entries and exits eliminate many problems people have with deciding when to buy and sell.
As for which stocks to trade, consider the strong uptrending stocks listed on the Best Swing Trading Stocks page which is updated each month.
I present strategies as I like to trade them or in ways that work best for me. I assume that people will take the elements they like and incorporate those elements into their own trading style and preferences. Use this strategy as it is, or as a springboard for a new strategy idea based on similar concepts.
Trend Strategy for High Momentum Stocks
This strategy uses an indicator called ATR Stops combined with high momentum stocks. If you trade stocks that are flat or have little movement, the results will be poor. Trade strocks in strong uptrends and results will be better.
This strategy uses a daily chart. If you want to use it on other time frames, test it first. I haven’t checked if it works on other timeframes or markets.
ATR Stops is available on TradingView. Other trading platforms likely have something similar.
The premise of the strategy is that we enter near the close of the day when the indicator is going to turn green or turn bullish. We know it is going to turn bullish if the price is going to close above the red/bearish ATR Stops level. We could also enter a trade on the next open, once we have confirmed the ATR Stops has turned green/bullish, assuming the open price is near the prior closing price (because the prior close is the actual trade signal).
We exit a long trade near the close of the day when the price is going to close below the green/bullish ATR Stops level and will turn red.
We remain in the trade until the exit signal occurs. This tends to capture a bulk of the trend in strong stocks. We are entering as the price is starting to move up after a sideways period or pullback, and then we exit after the price has rallied and is starting to pull back again.
Expect trades to last several days to a few weeks in most cases.
This is not a fixed stop loss or fixed target type strategy. We don’t know our risk/reward at the outset of the trade. Yet, over many trades we can assess our reward to risk and adjust which trades we take to fine-tune this statistic. Same goes for the win rate.
Stock Trend Strategy: Entry and Exit Method Based on ATR
In strongly rising stocks we wait for a pullback as indicated by the price moving below the ATR Stops indicator which turns it red (and it flips above the price).
We then buy when the price is going to have a daily close above ATR Stops red line, which will turn it green and flip it back below the price. We aren’t “assuming” what will happen, we actually have to wait till near the end of the day to make sure the price is actually doing to close above the red ATR Stop line. An alternative is to enter on the next open if it is still near the prior close price. Don’t chase the price. If you missed it, let it go. Chasing price means your risk increases and your profit potential drops.
We exit when the price is going to have a daily close below the green ATR Stops line.
Also, exit before earnings come out. I don’t recommend holding through earnings.
As for the exits, if the price is moving sideways just above the ATR Stops line, there is the option to place a stop loss a cents below the line instead of waiting for a daily candle to close below the line. If the price does drop, you will have saved yourself some money/profit. But there’s also the possibility the price drops below the line, but doesn’t close down there (so technically you would still be in the trade if you hadn’t placed a stop loss) and then keeps going higher without you.
If you like how the stock moves in relation to the ATR Stops indicator, there is also the option to exit any trade if the price drops slightly below the ATR Stops line, without waiting for a daily close. This has similar pros and cons to the scenario discussed above.
For the chart above, the alternative exit saved us a bit of money. The price had already flatlined and then the price dropped stopping us out anyway. By putting a stop loss near the ATR Stops line, we increased our profit slightly and reduced our loss slightly on the second trade, compared to waiting for the close of the day.
ATR Stops Settings for Trend Strategy Entries and Exits
As a general guideline, ATR Stops settings of 6 periods and 1.5xATR will do fairly well in many stocks, but not all.
For each stock I trade I decide which settings I’ll use. The 6 stays the same, but for some stocks a 2, 2.5, or 3x ATR may be better. Essentially we want to see the ATR Stop tracking the trending moves pretty closely, but not so close that we get stopped by tiny fluctuations. Look at the history of the recent history of the stock to see what works best. 1.5x is going to work well much of the time, but 2 and 2.5 are also pretty common settings I use. If you’re interested in trading a stock, add the indicator and try a few different settings.
There is also the option to leave the setting alone, and then only trend trade high momentum stocks that appear to do well with those settings.
Position Sizing for This Trend Strategy
We don’t know exactly what our risk is on each trade since we aren’t using a fixed price point for our stop loss. We are generally going to be using closing prices that are below the ATR Stops line.
If you choose to place a stop loss a few cents below the ATR Stops line, then you will know your exact risk at the start of the trade. In this case, position sizing is straightforward, and is covered in the Stock Position Sizing article.
If you are doing to use a closing price for the exit, we can only estimate our risk and then calculate our position size based on that.
- Take the difference between your entry point and the green line at the time of the trade (which should now be visible if the price is currently above the prior candle’s red line). If entry is $100 and the green line is at $95, that’s a 5% risk.
- Multiply this percentage by 1.2 to 1.5. We’re assuming risk will actually be 6% to 7.5%.
- Pick your estimated risk level. Say 7%. It’s optional to place a stop loss at this level at the time of the trade. After that, wait for the daily close below the ATR Stops to trigger the exit (or whatever method you have chosen).
- We only want to risk 1% of our capital on any given trade. Therefore, divide account capital by 7 (whatever the % risk of the trade). This is how much you put into the trade. If using a $50k account / 7 = $7142 into the trade.
- This means a position size of $7142 divided by $100 (which is the entry price) = 71 shares.
- If you lose 7% of $7142, that’s $500, which is 1% of $50K.
- Even if our risk estimate is off, and the price closes well below the green line, and we lose 10%, we will have lost $714, which is 1.4% of the account. More than we wanted, but because we already took precautions in our estimate, our loss is still very manageable.
Another example is described below using an actual chart.
Because this is a trailing stop loss approach, assuming the price moves in our direction at all after entering, the risk will decrease. The ATR Stops line will move up along with our potential exit point.
Full losses are relatively rare. Generally, with this type of strategy we end up with lots of smaller (than initial risk) losses, lots of small profits, and the odd big win.
Don’t Take Every Trend Signal
Here are some helpful hints to help get the most of this strategy:
- Look at charts with ATR Stops applied and study the conditions that are present when the stocks tend to run. Also note the times when the signals don’t work as well (choppy conditions). Come up with rules or guidelines that help you get into the good runs and also avoid most of the chop. We’ll never be perfect, the goal is just to note tendencies and trade based on those to produce an overall profit.
- Avoid going long in down-trending stocks. Wait until the stock has shown price action evidence of a trend reversal to the upside. THEN we start looking for these Trend Strategy signals.
- Avoid taking these trades when the price is moving sideways in a range, unless the range is large enough that prior trades within the range (based on these signals) produced a nice profit.
- Don’t take or hold trades through earnings. Exit before earnings.
- Entry signals that occur just after earnings can often be explosive winners.
- The win rate or average profit is going to be lower for this strategy when overall market conditions are poor and the indices are in a downtrend. Consider avoiding trading or realize you may make less or lose more.
For further guidance on trend trading as well as additional strategies, see the Complete Method Stock Swing Trading Course. I will be adding a section to the Course specifically on this strategy for ways to enhance returns and further fine-tune which stocks to trade, as well as how to find and track ideal setups so we are ready for them when they appear.
Can We Apply This Trend Strategy to Any Random Stock?
This strategy is meant for high momentum stocks. If you apply the ATR Stops to any stock and trade the signals, it may work out, it may not.
Here’s the method applied to Apple (AAPL) from 2021 through to August 2022.
If you bought and held AAPL over this time, you made about 30%.
If you only took the Trend Strategy ATR buy signals (no shorting), you made 29%, but you were invested less than half the time, so you could have used that money to trade another stock, potentially doubling the return. You also didn’t have trades during the big drawdowns or earnings, which can be stressful to hold through.
If you took the long and short signals, the gain was 34.76%.
Note that over this period AAPL was an average to better than average stock. It kept pace with the S&P 500, sometimes being a little stronger or weaker. Therefore, it would not be a stock we would be shorting. Shorting AAPL was basically a waste of capital. While we made another 5% in profit, between the longs and shorts we were invested most of this time. Instead of being short AAPL, we could have used that capital for better opportunities, buying very strong stocks or shorting very stocks. In both cases, we likely would have made much more with that capital.
Ideally, we are trading stocks much stronger than the indices (recently), as shown on the Best Swing Trading Stocks Lists.
So the strategy still faired quite well, but it could fair better if we are applying the strategy to the stocks it is meant for…HIGH-MOMENTUM STOCKS that tend to move a lot.
The strategy also faired decently in AAPL because over the longer-term the stock has been strong relative to the S&P 500 and is in an overall uptrend, so buying the pullbacks as the price started moving higher worked out well. That may not be the case in a stock that is weaker than the S&P 500 or in an overall downtrend (we look to short those).
Basically, you could apply this strategy to big-name stocks that tend to have large trending moves. It will probably do ok, but the strategy hasn’t been tested for this purpose. It is designed and tested on stocks that are high-flyers, with the option to short very weak stocks.
Trending Strategy FAQs
Here are some common questions that arise when discussing trend trading in stocks.
Why use ATR with a trend strategy?
ATR shows how much a stock tends to move each day. By exiting (entering) trades based on a multiple of ATR, traders can avoid getting stopped out (triggered in) on tiny price gyrations. ATR-based entries and exits show the price has moved more than the typical amount in a particular direction. This could be the start of a bigger price move, and thus may warrant an entry or exit.
How can you pick tops and bottoms in stocks?
Trying to pick exact tops and bottoms is ill-advised. Utilizing a strategy that waits for the stock to start rising, before entering, is a more prudent approach. Similarly, when looking to sell, take profits at an established profit target, utilize a trailing stop loss, or exit when the price starts to drop. There are no issues with taking profits on the way up. Strive to capture the bulk of the trend, not every single cent.
Can moving averages be used to trade stock trends?
Yes, moving averages are useful during trending environments. Traders can buy when the price moves above a moving average and can sell when the price drops below. Alternatively, use two moving averages. When the shorter-length MA crosses above the longer-length MA, that’s a buy signal, and when it crosses back below, that’s the sell signal.
You could replace the ATR Stops in the strategy above with a moving average, but you would need to verify for yourself the ideal settings and whether it is profitable for you or not.
What is the downside of trend trading stocks?
The downside of trend trading includes:
- There aren’t always high-quality trends to trade.
- You need to scan for and find high-quality trends to trade.
- No matter what strategy is used, it can be hard to stay in a trade when a stock is making a large favorable price move. Small gyrations can scare traders out or trigger their (trailing) stop loss. The goal is to capture a part of the trend; it’s difficult to capture it all.
- When the price stops trending, entry signals will typically result in losses, breakeven, or only tiny profits. Choppy conditions are not favorable for trend trading strategies.
- Most stocks move together. That means if the stock indices are flat and not moving, there will be few stocks offering great trend trading opportunities.
These are a few potential pitfalls to trend trading, but the rewards outweigh the cons in my experience.
Want more like this? Start learning with the Complete Method Stock Swing Trading Course.
Cory Mitchell, CMT
Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, even more than deposited if using leverage.