INSIDE INVESTOR: The trend is your friend

Trading with the underlying trend is often the best option for those looking to keep consistent returns over the longer term.

Anyone remotely interested in financial markets or simply managing their own superannuation fund would probably have heard the saying ‘the trend is your friend’. While it’s commonly bandied about, actually putting the very simple concept to work is an entirely different story.

So why is it recommended to invest with the trend? The easiest way to explain this is to ask whether you'd rather swim up or down stream in a river. Obviously, it is much easier to swim with the underlying current than against it, and this is the same when it comes to investing in tradeable securities, whether they are stocks, ETFs, commodities or currencies.

Trends in financial markets are caused by demand/supply imbalances, which could be caused by any number of factors. Once set in motion, it usually takes a lot of energy to reverse a trend, especially when they have been in place for a long period of time. Hence, investments in the direction of the underlying trend are said to have much better odds of success.

For those with a medium to long term time horizon, understanding the long term trend is the best way to allocate investments. Usually, like many things in life, the simplest methods are often the best.

Using BHP as an example, the simplest way to determine the trend is to visually inspect the chart. If it starts somewhere towards the bottom left and rises towards the top right, you can safely assume the trend is to the upside. If you want to get a little more involved you can draw a trend line connecting at least three price points.

The advantage this gives the investor is that it acts as a warning sign for when the trend may be changing. If prices start to move below the uptrend line, then it may be time to start reconsidering the investment.

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