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The Trend Following Trading Strategy
This trend following trading strategy article will teach you how to use the Ichimoku Indicator to follow trends. You’ll use this indicator to enter and exit trades successfully. Ichimoku Kinko Hyo gauges support and resistance then determines the future price movement. Many traders are intimidated by this new strategy, especially if they have never used the Ichimoku indicator before. Although, despite it’s complexity, the trend following trading strategy is actually easy to learn. With a little practice and patience, it can be a very successful trading strategy. If this strategy is too difficult, try our Parabolic SAR+Moving Average Trading strategy instead.
Ichimoku trading strategies are hard to come by because this indicator is complicated for many traders. This is one of the more advanced ichimoku trading strategies you will find. It is actually very simple to use. You are going to learn about the ichimoku 5 min strategy, ichimoku buy sell signals, ichimoku settings, ichimoku kinko hyo indicator, simple trend following strategy, and more aspects of this special indicator.
Ichimoku Indicator Basics:
Before we get started with this trading strategy, let me explain how this indicator works. There are 5 lines and they are all different colors to make it easy to identify the different lines.
Kijun Sen (blue line): This line can also be called the standard line and even the base line. The way that this is calculated, is by averaging the highest high and the lowest low for the past 26 periods.
Tenkan Sen (red line): This line is called the turning line. The calculation for this line is averaging the highest high and the lowest low for the past nine periods.
Chikou Span ( dark green line): What this line does is give you the closing price of today and is plotted 26 periods behind.
Senkou Span (lime green, orange,): Two lines make up the Senkou Span. The first line (lime green)is calculated by the average of Tenkan and Kijun Sen and is plotted 26 periods ahead. The second line (orange)is determined by averaging the highest high and the lowest low for the past 52 periods and plotted 26 periods ahead.
Kumo Area The area in between the two points of the Senkou span is called Kumo. This can be defined as the space between senkou span A and B. The cloud edges identify current and potential future support and resistance points. In the future examples, you can easily identify this by the lime green/orange “cloud.”
Note* These settings are the default settings for this indicator. They can be adjusted but for this strategy, it needs to be used with the default settings.
Below will give you a great visual on what these different lines look like in a chart. As you can see each line is colored to make it simple to identify each of these.
This strategy should be used on higher time frames like the 30 minute,1 hour, 4 hour, 1 day, or even a month! The reason? Well, this particular indicator follows trends so a lower time frame, such as a minute time frame, will possibly give you a false reading. You can also read about Trader Profile Quiz.
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So let’s get started on this strategy!
Step One: Using Ichimoku Indicator to Find the Uptrend or Downtrend
Since this is a trend following strategy the first thing that needs to be identified is a trend. Do this on the one day, or four-hour time frame. These time frames will give you the best opportunity to identify a trend.
In the example below, we see an upward trend with three levels of support
Drawing trend lines is one of the simplest ways to find a trend. Draw the trend line where there is support or resistance. The example above has three different levels of support to confirm this uptrend.
This trading strategy will always go in the direction of the trend. So an uptrend will ALWAYS be a BUY. A downtrend will ALWAYS be a SELL. This strategy uses all of these tools to identify if a trend will keep going and gets you into the uptrend or downtrend. Here You can see a funny video about trading levels.
Perfect, let’s move on to the next step.
Step Two: Ichimoku Trading System The Tenkan Sen/ Kijun Sen Lines Cross
This next step using the Trend Following Trading Strategy, I will explain what criteria is needed for a trade entry.
Just to keep you on track, on the Tenkan Sen lines are Red, Kijun Sen lines are Blue. This crossing signal is going to tell you whether there is a strong bullish trend or a bearish trend.
When the Tenkan Sen line will cross above the Kijun Sen line, then this will give you an indication that there is a bullish trend.
You can see in the example below the lines clearly cross which is our indication that this bullish uptrend is strong.
These lines are designed to do that very thing when they cross each other.
After the cross happened the blue line (Kijun) is now below the red line (Tenkan). That means that the trend is going to keep heading upwards. This is not an indication that the trend is breaking.
This was used on a four-hour chart. This chart is the best time frame to use because it gives you a good overall picture of how the last few days have gone as far as it trending.
In this timeframe, The lines need to cross either in the Kumo, which in the picture above is the orange area, or right above the cloud in this example. This was a buy signal because the trend was bullish while the Tenkan Sen line crossed above the Kijun Sen line in the senkou span area (Kumo).
Note* If the lines cross below the Kumo area in an uptrend, do not buy/sell. The opposite can also be applied to a downtrend. If the lines cross above the Kumo area in a downtrend, do not sell/buy. The reason for this is because this would be a weak signal that the trend will keep going up or down. The trade must always be made to go in the direction of the trend.
Recapping our rules using the Trend Following Trading Strategy, these three things must happen in order to enter a trade using the Ichimoku Indicator.
- Identify the trend. This needs to be an upward or downward trend. The trade must go the direction of the trend.
- Tenkan Senlineneeds to crossKijun Sen line.
- When the two lines cross, they need to cross in one of these two specific areas. The first place would be in the Kumo area. The second will depend if its an upward or downward trend. In an upward trend, they need to cross above the Kumo area. During a downward trend, they need to cross below the Kumo area.
The example above shows that if the lines crossed below that Kumo area, this trade would not meet the criteria. But it crossed in the Kumo area so it met the criteria.
Note* This strategy is a trend following strategy. It is to help you identify a trend and identify that the trend will keep going either upward or downward.
Step 3: Determining an entry point Trend Following Trading Strategy
Determining an entry point should be very easy to do now. This is because once the Tenkan sen line crossed with the Kijun sen line either in the Kumo or just above or below on the four-hour time frame.
Now, simply drop down to a one-hour time frame chart and enter the trade. You may check other time frames, but there really is no need since you have already followed the rules to enter the trade on the four-hour time frame. This is just to give you a better perspective on where you are entering.
Step 4: Stop Loss point
Stop loss is always important to have in case the trade goes in the wrong direction and you are now stuck in a pickle whether to end the trade early or end it too late and lose it all!
So we need a stop loss to help us out. Do this on the four hour time chart to see when the last areas of support or resistance were.
There need to be two or more points of resistance or support. In the example below, you see that there were support levels. So in this example, it will go just below them.
Step five: Exit Strategy
The exit strategy using the Trend Following Trading Strategy will wait until and trend starts moving the wrong direction and the lines cross again. It is recommended to monitor this on the one-hour time frame to get the most accurate reading for this particular strategy.
The reason for this is that the trend is most likely coming to an end.
The trend can come back down, but once the lines cross over again it is time to exit the trade.
As you can see in the example the trend was slowly going back down. In the rules of this strategy, you will exit the trade if the lines cross over again.
So a trade may be 2 hours, 10 hours, 3 days or even a week! It depends on what the chart tells you and if it continues to follow the rules of the strategy.
The Trend Following Trading Strategy only uses this one indicator. That makes you focus on this indicator and does not make you have to keep checking others to see what they are telling you. Also, read my personal trading plan reviewed by Kimm Krompass.
It may seem complicated at first with all of the different colored lines, clouds, and so on, however, when you break it down with this simple strategy, it makes it so much easier to understand.
Make sure you remember to only be risking no more than 2% of your account! No matter how confident you are, you should always follow this to maximize your account.
Thank you for reading the Trend Following Trading Strategy that uses the Ichimoku Indicator to help you gain a massive amount of pips at a time!
Please leave a comment below if you have any questions about trend following strategy !
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A Comprehensive Guide to Trend Lines Strategy
Maybe you think you don’t need a step by step guide to writing a great business plan. Maybe you think you don’t need a template for writing a business plan. After all, some entrepreneurs succeed without writing a business plan. With great timing, solid business skills, entrepreneurial drive, and a little luck, some founders build thriving businesses without creating even an informal business plan.
But the odds are greater that those entrepreneurs fail.
Does a business plan make startup success inevitable? Absolutely not. But great planning often means the difference between success and failure. Where your entrepreneurial dreams are concerned, you should do everything possible to set the stage for success.
And that’s why a great business plan is one that helps you succeed.
The following is a comprehensive guide to creating a great business plan. We’ll start with an overview of key concepts. Then we’ll look at each section of a typical business plan:
- Executive Summary
- Overview and Objectives
- Products and Services
- Market Opportunities
- Sales and Marketing
- Competitive Analysis
- Management Team
- Financial Analysis
So first let’s gain a little perspective on why you need a business plan.
Many business plans are fantasies. That’s because many aspiring entrepreneurs see a business plan as simply a tool–filled with strategies and projections and hyperbole–that will convince lenders or investors the business makes sense.
That’s a huge mistake.
First and foremost, your business plan should convince you that your idea makes sense–because your time, your money, and your effort are on the line.
So a solid business plan should be a blueprint for a successful business. It should flesh out strategic plans, develop marketing and sales plans, create the foundation for smooth operations, and maybe–just maybe–convince a lender or investor to jump on board.
For many entrepreneurs, developing a business plan is the first step in the process of deciding whether to actually start a business. Determining if an idea fails on paper can help a prospective founder avoid wasting time and money on a business with no realistic hope of success.
So, at a minimum, your plan should:
- Be as objective and logical as possible. What may have seemed like a good idea for a business can, after some thought and analysis, prove not viable because of heavy competition, insufficient funding, or a nonexistent market. (Sometimes even the best ideas are simply ahead of their time.)
- Serve as a guide to the business’s operations for the first months and sometimes years, creating a blueprint for company leaders to follow.
- Communicate the company’s purpose and vision, describe management responsibilities, detail personnel requirements, provide an overview of marketing plans, and evaluate current and future competition in the marketplace.
- Create the foundation of a financing proposal for investors and lenders to use to evaluate the company.
A good business plan delves into each of the above categories, but it should also accomplish other objectives. Most of all, a good business plan is convincing. It proves a case. It provides concrete, factual evidence showing your idea for a business is in fact sound and reasonable and has every chance of success.
Who must your business plan convince?
First and foremost, your business plan should convince you that your idea for a business is not just a dream but can be a viable reality. Entrepreneurs are by nature confident, positive, can-do people. After you objectively evaluate your capital needs, products or services, competition, marketing plans, and potential to make a profit, you’ll have a much better grasp on your chances for success.
And if you’re not convinced, fine: Take a step back and refine your ideas and your plans.
Who can your business plan convince?
1. Potential sources of financing. If you need seed money from a bank or friends and relatives, your business plan can help you make a great case. Financial statements can show where you have been. Financial projections describe where you plan to go.
Your business plan shows how you will get there. Lending naturally involves risk, and a great business plan can help lenders understand and quantity that risk, increasing your chances for approval.
2. Potential partners and investors. Where friends and family are concerned, sharing your business plan may not be necessary (although it certainly could help).
Other investors–including angel investors or venture capitalists–generally require a business plan in order to evaluate your business.
3. Skilled employees. When you need to attract talent, you need something to show prospective employees since you’re still in the startup phase. Early on, your business is more of an idea than a reality, so your business plan can help prospective employees understand your goals–and, more important, their place in helping you achieve those goals.
4. Potential joint ventures. Joint ventures are like partnerships between two companies. A joint venture is a formal agreement to share the work–and share the revenue and profit. As a new company, you will likely be an unknown quantity in your market. Setting up a joint venture with an established partner could make all the difference in getting your business off the ground.
But above all, your business plan should convince you that it makes sense to move forward.
As you map out your plan, you may discover issues or challenges you had not anticipated.
Maybe the market isn’t as large as you thought. Maybe, after evaluating the competition, you realize your plan to be the low-cost provider isn’t feasible since the profit margins will be too low to cover your costs.
Or you might realize the fundamental idea for your business is sound, but how you implement that idea should change. Maybe establishing a storefront for your operation isn’t as cost-effective as taking your products directly to customers–not only will your operating costs be lower, but you can charge a premium since you provide additional customer convenience.
Think of it this way. Successful businesses do not remain static. They learn from mistakes, and adapt and react to changes: changes in the economy, the marketplace, their customers, their products and services, etc. Successful businesses identify opportunities and challenges and react accordingly.
Creating a business plan lets you spot opportunities and challenges without risk. Use your plan to dip your toe in the business water. It’s the perfect way to review and revise your ideas and concepts before you ever spend a penny.
Many people see writing a business plan as a “necessary evil” required to attract financing or investors. Instead, see your plan as a no-cost way to explore the viability of your potential business and avoid costly mistakes.
Now let’s look at the first section of your business plan: The Executive Summary.
The Executive Summary is a brief outline of the company’s purpose and goals. While it can be tough to fit on one or two pages, a good Summary includes:
- A brief description of products and services
- A summary of objectives
- A solid description of the market
- A high-level justification for viability (including a quick look at your competition and your competitive advantage)
- A snapshot of growth potential
- An overview of funding requirements
I know that seems like a lot, and that’s why it’s so important you get it right. The Executive Summary is often the make-or-break section of your business plan.
A great business solves customer problems. If your Summary cannot clearly describe, in one or two pages, how your business will solve a particular problem and make a profit, then it’s very possible the opportunity does not exist–or your plan to take advantage of a genuine opportunity is not well developed.
So think of it as a snapshot of your business plan. Don’t try to “hype” your business–focus on helping a busy reader get a great feel for what you plan to do, how you plan to do it, and how you will succeed.
Since a business plan should above all help you start and grow your business, your Executive Summary should first and foremost help you do the following.
1. Refine and tighten your concept.
Think of it as a written elevator pitch (with more detail, of course). Your Summary describes the highlights of your plan, includes only the most critical points, and leaves out less important issues and factors.
As you develop your Summary you will naturally focus on the issues that contribute most to potential success. If your concept is too fuzzy, too broad, or too complicated, go back and start again. Most great businesses can be described in several sentences, not several pages.
2. Determine your priorities.
Your business plan walks the reader through your plan. What ranks high in terms of importance? Product development? Research? Acquiring the right location? Creating strategic partnerships?
Your Summary can serve as a guide to writing the rest of your plan.
3. Make the rest of the process easy.
Once your Summary is complete, you can use it as an outline for the rest of your plan. Simply flesh out the highlights with more detail.
Then work to accomplish your secondary objective by focusing on your readers. Even though you may be creating a business plan solely for your own purposes, at some point you may decide to seek financing or to bring on other investors, so make sure your Summary meets their needs as well. Work hard to set the stage for the rest of the plan. Let your excitement for your idea and your business shine through.
In short, make readers want to turn the page and keep reading. Just make sure your sizzle meets your steak by providing clear, factual descriptions.
How? The following is how an Executive Summary for a bicycle rental store might read.
Blue Mountain Cycle Rentals will offer road and mountain bike rentals in a strategic location directly adjacent to an entrance to the George Washington National Forest. Our primary strategy is to develop Blue Mountain Cycle Rentals as the most convenient and cost-effective rental alternative for the thousands of visitors who flock to the area each year.
Once underway we will expand our scope and take advantage of high-margin new equipment sales and leverage our existing labor force to sell and service those products. Within three years we intend to create the area’s premier destination for cycling enthusiasts.
Company and Management
Blue Mountain Cycle Rentals will be located at 321 Mountain Drive, a location providing extremely high visibility as well as direct entry and exit from a primary national park access road. The owner of the company, Marty Cycle, has over twenty years experience in the bicycle business, having served as a product manager for ACME Cycles as well as the general manager of Epic Cycling.
Because of his extensive industry contacts, initial equipment inventory will be purchased at significant discounts from OEM suppliers as well by sourcing excess inventory from shops around the country.
Due to the somewhat seasonal nature of the business, part-time employees will be hired to handle spikes in demand. Those employees will be attracted through competitive wages as well as discounts products and services.
460,000 people visited the George Washington National Forest during the last twelve months. While the outdoor tourism industry as a whole is flat, the park expects its number of visitors to grow over the next few years.
- The economic outlook indicates fewer VA, WV, NC, and MD cycling enthusiasts will travel outside the region
- The park has added a camping and lodging facilities that should attract an increased number of visitors
- The park has opened up additional areas for trail exploration and construction, ensuring a greater number of single-track options and therefore a greater number of visitors
The market potential inherent in those visitors is substantial. According to third-party research data, approximately 30% of all cyclists would prefer to rent rather than transport their own bicycles, especially those who are visiting the area for reasons other than cycling.
The cycling shops located in Harrisonburg, VA, are direct and established competitor. Our two primary competitive advantages will be location and lower costs.
Our location is also a key disadvantage where non-park rentals are concerned. We will overcome that issue by establishing a satellite location in Harrisonburg for enthusiasts who wish to rent bicycles to use in town or on other local trails.
We will also use online tools to better engage customers, allowing them to reserve and pay online as well as create individual profiles regarding sizes, preferences, and special needs.
Blue Mountain Cycle Rentals expects to earn a modest profit by year two based on projected sales. Our projections are based on the following key assumptions:
- Initial growth will be moderate as we establish awareness in the market
- Initial equipment purchases will stay in service for an average of three to four years; after two years we will begin investing in “new” equipment to replace damaged or obsolete equipment
- Marketing costs will not exceed 14% of sales
- Residual profits will be reinvested in expanding the product and service line
We project first-year revenue of $720,000 and a 10% growth rate for the next two years. Direct cost of sales is projected to average 60% of gross sales, including 50% for the purchase of equipment and 10% for the purchase of ancillary items. Net income is projected to reach $105,000 in year three as sales increase and operations become more efficient.
Keep in mind this is just a made-up example of how your Summary might read. Also keep in mind this example focused on the rental business, so a description of products was not included. (They’ll show up later.) If your business will manufacture or sell products, or provide a variety of services, then be sure to include a Products and Services section in your Summary. (In this case the products and services are obvious, so including a specific section would be redundant.)
Bottom line: Provide some sizzle in your Executive Summary. but make sure you show a reasonable look at the steak, too.
Overview and Objectives
Providing an overview of your business can be tricky, especially when you’re still in the planning stages. If you already own an existing business, summarizing your current operation should be relatively easy; it can be a lot harder to explain what you plan to become.
So start by taking a step back.
Think about what products and services you will provide, how you will provide those items, what you need to have in order to provide those items, exactly who will provide those items. and most importantly, whom you will provide those items to.
Consider our bicycle rental business example. It’s serves retail customers. It has an online component, but the core of the business is based on face-to-face transactions for bike rentals and support.
So you’ll need a physical location, bikes, racks and tools and supporting equipment, and other brick-and-mortar related items. You’ll need employees with a very particular set of skills to serve those customers, and you’ll need an operating plan to guide your everyday activities.
Sound like a lot? It boils down to:
- What you will provide
- What you need to run your business
- Who will service your customers, and
- Who are your customers
In our example, defining the above is fairly simple. You know what you will provide to meet your customer’s needs. You will of course need a certain quantity of bikes to service demand, but you will not need a number of different types of bikes. You need a retail location, furnished to meet the demands of your business. You need semi-skilled employees capable of sizing, customizing, and repairing bikes.
And you know your customers: Cycling enthusiasts.
In other businesses and industries answering the above questions can be more difficult. If you open a restaurant, what you plan to serve will in some ways determine your labor needs, the location you choose, the equipment you need to purchase. and most importantly will help define your customer. Changing any one element may change other elements; if you cannot afford to purchase expensive kitchen equipment, you may need to adapt your menu accordingly. If you hope to attract an upscale clientele, you may need to invest more in purchasing a prime location and creating an appealing ambience.
So where do you start? Focus on the basics first:
- Identify your industry: Retail, wholesale, service, manufacturing, etc. Clearly define your type of business.
- Identify your customer. You cannot market and sell to customers until you know who they are.
- Explain the problem you solve. Successful businesses create customer value by solving problems. In our rental example, one problem is cycling enthusiasts who don’t–or can’t–travel with bikes. Another problem is casual cyclists who can’t–or choose not to–spend significant sums on their own bikes. The rental shop will solve that problem by offering a lower-cost and convenient alternative.
- Show how you will solve that problem. Our rental shop will offer better prices and enhanced services like remote deliveries, off-hours equipment returns, and online reservations.
If you are still stuck, try answering these questions. Some may pertain to you; others may not.
- Who is my average customer? Who am I targeting? (Unless you plan to open a grocery store, you should be unlikely to answer, “Everyone!”)
- What pain point do I solve for my customers?
- How will I overcome that paint point?
- Where will I fail to solve a customer problem. and what can I do to overcome that issue? (In our rental example one problem is a potential lack of convenience; we will overcome that issue by offering online reservations, on-resort deliveries, and drive-up equipment returns.)
- Where will I locate my business?
- What products, services, and equipment do I need to run my business?
- What skills do my employees need, and how many do I need?
- How will I beat my competition?
- How can I differentiate myself from my competition in the eyes of my customers? (You can have a great plan to beat your competition but you also must win the perception battle among your customers. If customers don’t feel you are different. then you aren’t truly different. Perception is critical.)
Once you work through this list you will probably end up with a lot more detail than is necessary for your business plan. That is not a problem: Start summarizing the main points. For example, your Business Overview and Objectives section could start something like this:
History and Vision
Blue Mountain Cycle Rentals is a new retail venture that will be located at 321 Mountain Drive, directly adjacent to an extremely popular cycling destination. Our initial goal is to become the premier provider for bicycle rentals. We will then leverage our customer base and position in the market to offer new equipment sales as well as comprehensive maintenance and service, custom equipment fittings, and expert trail advice.
- Achieve the largest market share bicycle rentals in the area
- Generate a net income of $235,000 at the end of the second year of operation
- Minimize rental inventory replacement costs by maintaining a 7% attrition rate on existing equipment (industry average is 12%)
Keys to Success
- Provide high quality equipment, sourcing that equipment as inexpensively as possible through existing relationships with equipment manufacturers and other cycling shops
- Use signage to attract visitors traveling to the national forest, highlighting our cost and service advantage
- Create additional customer convenience factors to overcome a perceived lack of convenience for customers planning to ride roads and trails some distance away from our shop
- Develop customer incentive and loyalty programs to leverage customer relationships and create positive word of mouth
You could certainly include more detail in each section; this is simply a quick guide. And if you plan to develop a product or service, you should thoroughly describe the development process as well as the end result.
The key is to describe what you will do for your customers–if you can’t, you won’t have any customers.
Products and Services
In the Products and Services section of your business plan, you will clearly describe–yep–the products and services your business will provide.
Keep in mind that highly detailed or technical descriptions are not necessary and definitely not recommended. Use simple terms and avoid industry buzzwords.
On the other hand, describing how the company’s products and services will differ from the competition is critical. So is describing why your products and services are needed if no market currently exists. (For example, before there was Federal Express, overnight delivery was a niche business served by small companies. FedEx had to define the opportunity for a new, large-scale service and justify why customers needed–and would actually use–that service.)
Patents, copyrights, and trademarks you own or have applied for should also be listed in this section.
Depending on the nature of your business, your Products and Services section could be very long or relatively short. If your business is product-focused, you will want to spend more time describing those products.
If you plan to sell a commodity item and the key to your success lies in, say, competitive pricing, you probably don’t need to provide significant product detail. Or if you plan to sell a commodity readily available in a variety of outlets, the key to your business may not be the commodity itself but your ability to market in a more cost-effective way than your competition.
But if you’re creating a new product (or service), make sure you thoroughly explain the nature of the product, its uses, and its value, etc — otherwise your readers will not have enough information to evaluate your business.
Key questions to answer:
- Are products or services in development or existing (and on the market)?
- What is the timeline for bringing new products and services to market?
- What makes your products or services different? Are there competitive advantages compared with offerings from other competitors? Are there competitive disadvantages you will need to overcome? (And if so, how?)
- Is price an issue? Will your operating costs be low enough to allow a reasonable profit margin?
- How will you acquire your products? Are you the manufacturer? Do you assemble products using components provided by others? Do you purchase products from suppliers or wholesalers? If your business takes off, is a steady supply of products available?
In the cycling rental business example we’ve been using, products and services could be a relatively simple section to complete or it could be fairly involved. It depends on the nature of the products the company plans to rent to customers.
If Blue Mountain Cycling Rentals plans to market itself as a provider of high-end bikes, describing those bikes–and the sources for those bikes–is important, since “high-end cycling rentals” is intended to be a market differentiation. If the company plans to be the low-cost provider, then describing specific brands of equipment is probably not necessary.
Also, keep in mind that if a supplier runs out of capacity–or goes out of business altogether–you may not have a sufficient supply to meet your demand. Plan to set up multiple vendor or supplier relationships, and describe those relationships fully.
Remember, the primary goal of your business plan is to convince you that the business is viable–and to create a road map for you to follow.
The Products and Services section for our cycling rental business could start something like this:
Blue Mountain Cycle Rentals will provide a comprehensive line of bicycles and cycling equipment for all ages and levels of ability. Since the typical customer seeks medium-quality equipment and excellent services at competitive prices, we will focus on providing brands like Trek bikes, Shimano footwear, and Giro helmets. These manufacturers have a widespread reputation as mid- to high-level quality, unlike equipment typically found in the rental market.
The following is a breakdown of anticipated rental price points, per day and per week:
- Bicycle $30 $120
- Helmet $6 $30
- Customers can extend the rental term online without visiting the store.
- A grace period of two hours will be applied to all rentals; customers who return equipment within that two-hour period will not be charged an additional fee.
Blue Mountain Cycle Rentals will have clear advantages over its primary competitors, the bike shops located in Harrisonburg, VA:
- Newer equipment inventory with higher perceived quality
- Price points 15 percent below the competition
- Online renewals offering greater convenience
- A liberal return grace period that will reinforce our reputation as a customer-friendly rental experience
Expansion will allow us to move product offerings into new equipment sales. We will also explore maintenance and fitting services, leveraging our existing maintenance staff to provide value-added services at a premium price.
When you draft your Products and Services section, think of your reader as a person who knows little to nothing about your business. Be clear and to the point.
Think of it this way: The Products and Services section answers the “what” question for your business. Make sure you fully understand the “what” factor; you may run the business, but your products and services are its lifeblood.
Market research is critical to business success. A good business plan analyzes and evaluates customer demographics, purchasing habits, buying cycles, and willingness to adopt new products and services.
The process starts with understanding your market and the opportunities inherent in that market. And that means you’ll need to do a little research. Before you start a business you must be sure there is a viable market for what you plan to offer.
That process requires asking, and more importantly answering, a number of questions. The more thoroughly you answer the following questions, the better you will understand your market.
Start by evaluating the market at a relatively high level, answering some high-level questions about your market and your industry:
- What is the size of the market? Is it growing, stable, or in decline?
- Is the overall industry growing, stable, or in decline?
- What segment of the market do I plan to target? What demographics and behaviors make up the market I plan to target?
- Is demand for my specific products and services rising or falling?
- Can I differentiate myself from the competition in a way customers will find meaningful? If so, can I differentiate myself in a cost-effective manner?
- What do customers expect to pay for my products and services? Are they considered to be a commodity or to be custom and individualized?
Fortunately, you’ve already done some of the legwork. You’ve already defined and mapped out your products and services. The Market Opportunities section provides a sense-check of that analysis, which is particularly important since choosing the right products and services is such a critical factor in business success.
But your analysis should go farther: Great products are great. but there still must be a market for those products. (Ferraris are awesome but you’re unlikely to sell many where I live.)
So let’s dig deeper and quantify your market. Your goal is to thoroughly understand the characteristics and purchasing ability of potential customers in your market. A little Googling can yield a tremendous amount of data.
For the market you hope to serve, determine:
- Your potential customers. In general terms, potential customers are the people in the market segment you plan to target. Say you sell jet skis; anyone under the age of 16 and over the age of 60 or so is unlikely to be a customer. Plus, again in general terms, women make up a relatively small percentage of jet ski purchasers. Determining the total population for the market is not particularly helpful if your product or service does not serve a need for the entire population. Most products and services do not.
- Total households. In some cases determining the number of total households is important depending on your business. For example, if you sell heating and air conditioning systems, knowing the number of households is more important than simply knowing the total population in your area. While people purchase HVAC systems, “households” consume those systems.
- Median income. Spending ability is important. Does your market area have sufficient spending power to purchase enough of your products and services to enable you to make a profit? Some areas are more affluent than others. Don’t assume every city or locality is the same in terms of spending power. A service that is viable in New York City may not be viable in your town.
- Income by demographics. You can also determine income levels by age group, by ethnic group, and by gender. (Again, potential spending power is an important number to quantify.) Senior citizens could very well have a lower income level than males or females age 45 to 55 in the prime of their careers. Or say you plan to sell services to local businesses; try to determine the amount they currently spend on similar services.
The key is to understand the market in general terms and then to dig deeper to understand whether there are specific segments within that market–the segments you plan to target–that can become customers and support the growth of your business.
Also keep in mind that if you plan to sell products online the global marketplace is incredibly crowded and competitive. Any business can sell a product online and ship that product around the world. Don’t simply assume that just because “the bicycle industry is a $62 billion business” (a number I just made up) that you can capture a meaningful percentage of that market.
On the other hand, if you live in an area with 50,000 people and there’s only one bicycle shop, you may be able to enter that market and attract a major portion of bicycle customers in your area.
Always remember it’s much easier to serve a market you can define and quantify.
After you complete your research you may feel a little overwhelmed. While data is good, and more data is great, sifting through and making sense of too much data can be daunting.
For the purposes of your business plan, narrow your focus and focus on answering these main questions:
- What is your market? Include geographic descriptions, target demographics, and company profiles (if you’re B2B). In short: Who are your customers?
- What segment of your market will you focus on? What niche will you attempt to carve out? What percentage of that market do you hope to penetrate and acquire?
- What is the size of your intended market? What is the population and spending habits and levels?
- Why do customers need and why will they be willing to purchase your products and services?
- How will you price your products and services? Will you be the low cost provider or provide value-added services at higher prices?
- Is your market likely to grow? How much? Why?
- How can you increase your market share over time?
The Market Opportunities section for our cycling rental business could start something like this:
Consumer spending on cycling equipment reached $9,250,000 in the states of VA, WV, MD, and NC last year. While we expect sales to rise, for the purposes of performing a conservative analysis we have projected a zero growth rate for the next three years.
In those states 2,500,000 people visited a national forest last year. Our target market includes customers visiting the Shenandoah National Forest; last year 120,000 people visited the area during spring, summer, and fall months.
Over time, however, we do expect equipment rentals and sales to increase as the popularity of cycling continues to rise. In particular we forecast a spike in demand in 2020 since the national road racing championships will be held in Richmond, VA.
Participation and population trends favor our venture:
- Recreational sports in general and both family-oriented and “extreme” sports continue to gain in exposure and popularity.
- Western VA and eastern WV have experienced population growth rates nearly double that of the country as a whole.
- Industry trends show cycling has risen at a more rapid rate than most other recreational activities.
According to the latest studies, recreation spending in our target market has grown by 14% per year for the past three years.
In addition, we anticipate greater than industry-norm growth rates for cycling in the area due to the increase in popularity of cycling events like the Alpine Loop Gran Fondo.
Out target market has one basic need: The availability to source bicycle rentals at a competitive price. Our only other competition are the bike shops in Harrisonburg, VA, and our location will give us a competitive advantage over those and other companies who try to serve our market.
You may want to add other categories to this section based on your particular industry.
For example, you might decide to provide information about Market Segments. In our case the cycling rental business does not require much segmentation. Rentals are typically not broken down into segments like “inexpensive,” “mid-range,” and “high-end.” For the most part rental bikes are more of a commodity. (Although you’ll notice in our Products and Services section we decided to provide “high-end” rentals.)
But say you decide to open a clothing store. You could focus on high fashion, or children’s clothes, or outdoor wear, or casual. you could segment the market in a number of ways. If that’s the case, provide detail on segmentation that supports your plan.
The key is to define your market — and then show how you will serve your market.
Sales and Marketing
Providing great products and services is wonderful, but customers must actually know those products and services exist. That’s why marketing plans and strategies are critical to business success. (Duh, right?)
But keep in mind marketing is not just advertising. Marketing–whether advertising, public relations, promotional literature, etc–is an investment in the growth of your business.
Like any other investment you would make, money spent on marketing must generate a return. (Otherwise why make the investment?) While that return could simply be greater cash flow, good marketing plans result in higher sales and profits.
So don’t simply plan to spend money on a variety of advertising efforts. Do your homework and create a smart marketing program.
Here are some of the basic steps involved in creating your marketing plan:
- Focus on your target market. Who are your customers? Who will you target? Who makes the decisions? Determine how you can best reach potential customers.
- Evaluate your competition. Your marketing plan must set you apart from your competition, and you can’t stand out unless you know your competition. (It’s hard to stand out from a crowd if you don’t know where the crowd stands.) Know your competitors by gathering information about their products, service, quality, pricing, and advertising campaigns. In marketing terms, what does your competition do that works well? What are their weaknesses? How can you create a marketing plan that highlights the advantages you offer to customers?
- Consider your brand. How customers perceive your business makes a dramatic impact on sales. Your marketing program should consistently reinforce and extend your brand. Before you start to market your business, think about how you want your marketing to reflect on your business and your products and services. Marketing is the face of your to potential customers–make sure you put your best face forward.
- Focus on benefits. What problems do you solve? What benefits do you deliver? Customers don’t think in terms of products–they think in terms of benefits and solutions. Your marketing plan should clearly identify benefits customers will receive. Focus on what customers get instead of on what you provide. (Take Dominos; theoretically they’re in the pizza business, but really they’re a delivery business.)
- Focus on differentiation. Your products and services have to stand out from the competition in some way. How will you compete in terms of price, product, or service?
Then focus on providing detail and backup for your marketing plan.
Key questions to answer:
- What is your budget for sales and marketing efforts?
- How will you determine if your initial marketing efforts are successful? In what ways will you adapt if your initial efforts do not succeed?
- Will you need sales representatives (inside or external) to promote your products?
- Can you set up public relations activities to help market your business?
The Sales and Marketing section for our cycling rental business could start something like this:
The target market for Blue Mountain Cycling Rentals is western VA, eastern WV, southwestern MD, and northern NC. While customers in the counties surrounding the George Washington National Forest make up 35% of our potential customer base, much of our market travels from outside that geographic area.
Our marketing strategy will focus on three basic initiatives:
- Road signage. Access to the forest is restricted to a few primary entrances, and visitors reach those entrances after traveling on one of several main roadways. Since customers currently rent bicycles in the local town of Harrisonburg, road signage will communicate our value proposition to all potential customers.
- Web initiatives. Our website will attract potential visitors to the resort. We will partner with local businesses that serve our target market to provide discounts and incentives.
- Promotional events. We will hold regular events with professional cyclists, like demonstrations and autograph signings, to bring more customers to the store as well as to extend the athletes’ “brand” to our brand.
We will not be the low-cost provider for our target market. Our goal is to provide mid- to high-end equipment. However, we will create web-based loyalty programs to incent customers to set up online profiles and reserve and renew equipment rentals online, and provide discounts for those who do. Over time we will be able to market specifically to those customers.
Just like in the Market Opportunity section, you may want to include a few more categories. For example, if your business involves a commission-compensated sales force, describe your Sales Programs and incentives. If you distribute products to other companies or suppliers and those distribution efforts will impact your overall marketing plans, lay out your Distribution Strategy.
The key is to show you understand your market and you understand how you will reach your market. Marketing and promotions must result in customers–your goal is to thoroughly describe how you will acquire and keep your customers.
Also keep in mind you may want to include examples of marketing materials you have already prepared, like website descriptions, print ads, web-based advertising programs, etc. While you don’t need to include samples, taking the time to create actual marketing materials might help you better understand and communicate your marketing plans and objectives.
Make sure your Sales & Marketing section answers the “How will I reach my customers?” question.
The Competitive Analysis section of your business plan is devoted to analyzing your competition–both your current competition and potential competitors who might enter your market.
Every business has competition. Understanding the strengths and weaknesses of your competition–or potential competition–is critical to making sure your business survives and grows. While you don’t need to hire a private detective, you do need to thoroughly assess your competition on a regular basis even if you only plan to run a small business.
In fact, small businesses can be especially vulnerable to competition, especially when new companies enter a marketplace.
Competitive analysis can be incredibly complicated and time-consuming. but it doesn’t have to be. Here is a simple process you can follow to identify, analyze, and determine the strengths and weaknesses of your competition.
Profile Current Competitors
First develop a basic profile of each of your current competition. For example, if you plan to open an office supply store you may have three competing stores in your market.
Online retailers will also provide competition, but thoroughly analyzing those companies will be less valuable unless you also decide you want to sell office supplies online. (Although it’s also possible that they–or, say, Amazon–are your real competition. Only you can determine that.)
To make the process easier, stick to analyzing companies you will directly compete with. If you plan to set up an accounting firm, you will compete with other accounting firms in your area. If you plan to open a clothing store, you will compete with other clothing retailers in your area.
Again, if you run a clothing store you also compete with online retailers, but there is relatively little you can do about that type of competition other than to work hard to compete in other ways: great service, friendly salespeople, convenient hours, truly understanding your customers, etc.
Once you identify your main competitors, answer these questions about each one. And be objective. It’s easy to identify weaknesses in your competition, but less easy (and a lot less fun) to recognize where they may be able to outperform you:
- What are their strengths? Price, service, convenience, extensive inventory are all areas where you may be vulnerable.
- What are their weaknesses? Weaknesses are opportunities you should plan to take advantage of.
- What are their basic objectives? Do they seek to gain market share? Do they attempt to capture premium clients? See your industry through their eyes. What are they trying to achieve?
- What marketing strategies do they use? Look at their advertising, public relations, etc.
- How can you take market share away from their business?
- How will they respond when you enter the market?
While these questions may seem like a lot of work to answer, in reality the process should be fairly easy. You should already have a feel for the competition’s strengths and weaknesses. if you know your market and your industry.
To gather information, you can also:
- Check out their websites and marketing materials. Most of the information you need about products, services, prices, and company objectives should be readily available. If that information is not available, you may have identified a weakness.
- Visit their locations. Take a look around. Check out sales materials and promotional literature. Have friends stop in or call to ask for information.
- Evaluate their marketing and advertising campaigns. How a company advertises creates a great opportunity to uncover the objectives and strategies of that business. Advertising should help you quickly determine how a company positions itself, who it markets to, and what strategies it employs to reach potential customers.
- Browse. Search the Internet for news, public relations, and other mentions of your competition. Search blogs and Twitter feeds as well as review and recommendation sites. While most of the information you find will be anecdotal and based on the opinion of just a few people, you may at least get a sense of how some consumers perceive your competition. Plus you may also get advance warning about expansion plans, new markets they intend to enter, or changes in management.
Keep in mind competitive analysis does more than help you understand your competition. Competitive analysis can also help you identify changes you should make to your business strategies. Learn from competitor strengths, take advantage of competitor’s weaknesses, and apply the same analysis to your own business plan.
You might be surprised by what you can learn about your business by evaluating other businesses.
Identify Potential Competitors
It can be tough to predict when and where new competitors may pop up. For starters, regularly search for news on your industry, your products, your services, and your target market.
But there are other ways to predict when competition may follow you into a market. Other people may see the same opportunity you see. Think about your business and your industry, and if the following conditions exist, you may face competition does the road:
- The industry enjoys relatively high profit margins
- Entering the market is relatively easy and inexpensive
- The market is growing–the more rapidly it is growing the greater the risk of competition
- Supply and demand is off–supply is low and demand is high
- Very little competition exists, so there is plenty of “room” for others to enter the market
In general terms, if serving your market seems easy you can safely assume competitors will enter your market. A good business plan anticipates and accounts for new competitors.
Now distill what you’ve learned by answering these questions in your business plan:
- Who are my current competitors? What is their market share? How successful are they?
- What market do current competitors target? Do they focus on a specific customer type, on serving the mass market, or on a particular niche?
- Are competing businesses growing or scaling back their operations? Why? What does that mean for your business?
- How will your company be different from the competition? What competitor weaknesses can you exploit? What competitor strengths will you need to overcome to be successful?
- What will you do if competitors drop out of the marketplace? What will you do to take advantage of the opportunity?
- What will you do if new competitors enter the marketplace? How will you react to and overcome new challenges?
The Competitive Analysis section for our cycling rental business could start something like this:
Our nearest and only competition is the bike shops in Harrisonburg, VA. Our next closest competitor is located over 100 miles away.
The in-town bike shops will be strong competitors. They are established businesses with excellent reputations. On the other hand, they offer inferior-quality equipment and their location is significantly less convenient.
We do not plan to sell bicycles for at least the first two years of operation. However, sellers of new equipment do indirectly compete with our business since a customer who buys equipment no longer needs to rent equipment.
Later, when we add new equipment sales to our operation, we will face competition from online retailers. We will compete with new equipment retailers through personalized service and targeted marketing to our existing customer base, especially through online initiatives.
- By offering mid- to high-end quality equipment, we provide customers the opportunity to “try out” bikes they may wish to purchase at a later date, providing additional incentive (besides cost savings) to use our service.
- Offering drive-up, express rental return services will be seen as a much more attractive option compared to the hassle of renting bikes in Harrisonburg and transporting them to intended take-off points for rides.
- Online initiatives like online renewals and online reservations enhances customer convenience and positions us as a cutting-edge supplier in a market largely populated, especially in the cycling segment, by customers who tend to be early technology adapters.
- Renting bikes and cycling equipment may be perceived by some of our target market as a commodity transaction. If we do not differentiate ourselves in terms of quality, convenience, and service, we could face additional competition from other entrants to the market.
- One of the bike shops in Harrisonburg is a subsidiary of a larger corporation with significant financial assets. If we, as hoped, carve out a significant market share, the corporation may use those assets to increase service, improve equipment quality, or cut prices.
While your business plan is primarily intended to convince you that your business makes sense, keep in mind most investors look closely at your competitive analysis. A common mistake made by entrepreneurs is assuming they will simply “do it better” than any competition.
Experienced businesspeople know you will face stiff competition: showing you understand your competition, understand your strengths and weaknesses relative to that competition, and that you understand you will have to adapt and change based on that competition, is critical.
And, even if you do not ever plan to seek financing or bring in investors, you absolutely must know your competition.
The Competitive Analysis section helps you answer the “Against whom?” question.
The next step in creating your business plan is to develop an Operations Plan that will serve your customers, keep your operating costs in line, and ensure profitability. Your ops plan should detail strategies for managing, staffing, manufacturing, fulfillment, inventory. all the stuff involved in operating your business on a day-to-day basis.
Fortunately, most entrepreneurs have a better handle on their operations plan than on any other aspect of their business. After all, while it may not seem natural to analyze your market or your competition, most budding entrepreneurs tend to spend a lot of time thinking about how they will run their businesses.
Your goal is to answer the following key questions:
- What facilities, equipment, and supplies do you need?
- What is your organizational structure? Who is responsible for which aspects of the business?
- Is research and development required, either during start-up or as an ongoing operation? If so, how will you accomplish this task?
- What are your initial staffing needs? When and how will you add staff?
- How will you establish business relationships with vendors and suppliers? How will those relationships impact your day-to-day operations?
- How will your operations change as the company grows? What steps will you take to cut costs if the company initially does not perform up to expectations?
Operations plans should be highly specific to your industry, your market sector, and your customers. Instead of providing an example like I’ve done with other sections, use the following to determine the key areas your plan should address:
Location and Facility Management
In terms of location, describe:
- Zoning requirements
- The type of building you need
- The space you need
- Power and utility requirements
- Access: Customers, suppliers, shipping, etc.
- Specialized construction or renovations
- Interior and exterior remodeling and preparation
- Production methods
- Service methods
- Inventory control
- Sales and customer service
- Receiving and Delivery
- Maintenance, cleaning, and re-stocking
- Licenses and permits
- Environmental or health regulations
- Patents, trademarks, and copyrights
- Typical staffing
- Breakdown of skills required
- Recruiting and retention
- Policies and procedures
- Pay structures
- Anticipated inventory levels
- Turnover rate
- Lead times
- Seasonal fluctuations in demand
- Major suppliers
- Back-up suppliers and contingency plans
- Credit and payment policies
Sound like a lot? It can be. but not all of the above needs to be in your business plan.
You should think through and create a detailed plan for each category, but you won’t need to share the results with the people who read your business plan
Working through each issue and developing concrete operations plans helps you in two major ways:
- If you don’t plan to seek financing or outside capital, you can still take advantage of creating a comprehensive plan that addresses all of your operational needs.
- If you do seek financing or outside capital, you may not include all the detail in your business plan–but you will have answers to any operations questions at your fingertips.
Think of Operations as the “implementation” section of your business plan. What do you need to do? How will you get it done? Then create an overview of that plan to make sure your milestones and timeline make sense.
That way the operations section answers the “How?” question.
Many investors and lenders feel the quality and experience of the management team is one of the most important factors used to evaluate the potential of a new business.
But putting work into the Management Team section will not only benefit people who may read your plan. It will also help you evaluate the skills, experiences, and resources your management team will need. Addressing your company’s needs during implementation will make a major impact on your chances for success.
Key questions to answer:
- Who are the key leaders? (If actual people have not been identified, describe the type of people needed.) What are their experiences, educational backgrounds, and skills?
- Do your key leaders have industry experience? If not, what experience do they bring to the business that is applicable?
- What duties will each position perform? (Creating an organization chart might be helpful.) What authority is granted to and what responsibilities are expected in each position?
- What salary levels will be required to attract qualified candidates for each position? What is the salary structure for the company, by position?
The Management Team section for our cycling rental business could start something like this:
Jim Rouleur, Owner and Manager
Joe has over twenty years experience in the cycling business. He served for ten years as a product manager for ACME Bikes. After that he was the Operations Manager of Single Track Cycles, a full-service bike shop located in Bend, Oregon. He has an undergraduate degree in marketing from Duke University and an MBA from Virginia Commonwealth University. (A complete resume for Mr. Rouleur can be found in the Appendix.(
Mary Gearset, Assistant Manager
Mary was the 2009 U.S. Mountain Biking National Champion. She worked in product development for High Tec frames, creating custom frames and frame modifications for professional cyclists. She also has extensive customer service and sales experience, having worked for four years as the online manager of Pro Parts Unlimited, an online retailer of high-end cycling equipment and accessories.
In some instances you may also wish to describe your staffing plans.
For example, if you manufacture a product or provide a service and will hire a key skilled employee, describe that employee’s credentials. Otherwise, include staffing plans in the Operations section.
One key note: Don’t be tempted to add a “name” to your management team in hopes of attracting investors. “Celebrity” management team members may attract the attention of your readers, but experienced lenders and investors will immediately ask what role that person will actually play in the running of the business–and in most cases those individuals won’t play any meaningful role.
If you don’t have a lot of experience–but are willing to work hard to overcome that lack of experience–don’t be tempted to include other people in your plan that will not actually work in the business.
If you can’t survive without help, that’s okay. In fact that’s expected; no one does anything worthwhile on their own. Just make plans to get help from the right people.
Finally, when you create your Management section, focus on credentials but pay extra focus to what each person actually will do. Experience and reputation are great, but action is everything.
That way your Management section will answer the “Who is in charge?” question.
Numbers tell the story. Bottom line results indicate the success or failure of any business.
Financial projections and estimates help entrepreneurs, lenders, and investors or lenders objectively evaluate a company’s potential for success. If a business seeks outside funding, providing comprehensive financial reports and analysis is critical.
But most importantly, financial projections tell you whether your business has a chance of being viable–and if not let you know you have more work to do.
Most business plans include at least five basic reports or projections:
- Balance Sheet: Describes the company cash position including assets, liabilities, shareholders, and earnings retained to fund future operations or to serve as funding for expansion and growth. It indicates the financial health of a business.
- Income Statement: Also called a Profit and Loss statement, this report lists projected revenue and expenses. It shows whether a company will be profitable during a given time period.
- Cash Flow Statement: A projection of cash receipts and expense payments. It shows how and when cash will flow through the business; without cash, payments (including salaries) cannot be made.
- Operating Budget: A detailed breakdown of income and expenses; provides a guide for how the company will operate from a “dollars” point of view.
- Break-Even Analysis: A projection of the revenue required to cover all fixed and variable expenses. Shows when, under specific conditions, a business can expect to become profitable.
It’s easy to find examples of all of the above. Even the most basic accounting software packages include templates and samples. You can also find templates in Excel and Google Docs. (A quick search like “google docs profit and loss statement” yields plenty of examples.)
Or you can work with an accountant to create the necessary financial projections and documents. Certainly feel free to do so. but first play around with the reports yourself. While you don’t need to be an accountant to run a business, you do need to understand your numbers. and the best way to understand your numbers is usually to actually work with your numbers.
But ultimately the tools you use to develop your numbers are not as important as whether those numbers are as accurate as possible–and whether those numbers help you decide whether to take the next step and put your business plan into action.
Then Financial Analysis can help you answer the most important business question: “Can we make a profit?”
Some business plans include less essential but potentially important information in an Appendix section. You may decide to include, as backup or additional information:
- Resumes of key leaders
- Additional descriptions of products and services
- Legal agreements
- Organizational charts
- Examples of marketing and advertising collateral
- Photographs of potential facilities, products, etc
- Backup for market research or competitive analysis
- Additional financial documents or projections
Keep in mind creating an Appendix is usually only necessary if you’re seeking financing or hoping to bring in partners or investors. Initially the people reading your business plan don’t wish to plow through reams and reams of charts, numbers, and backup information. If one does want to dig deeper, fine–he or she can check out the documents in the Appendix.
That way your business plan can share your story clearly and concisely.
Otherwise, since you created your business plan. you should already have the backup.
Tying It All Together
While you may use your business plan to attract investors, partners, suppliers, etc. Never forget that the goal of your business plan is to convince you that your idea makes sense.
Because ultimately it’s your time, your money, and your effort on the line.
Trend Lines in Technical Analysis: What Are They and How to Use Them
There are two rules about trends you should remember when investing:
“The trend is your friend” and “Do not trade against the trend”.
These are two of the most important rules to respect if you want to become a successful trader.
It’s common for beginners to invest against the trend, as they are looking for very short-term profits. They will, therefore, look for any kind of trading opportunities, good or bad. They will enter the markets without knowing if they are trading with or against the trend.
Trend lines are amazing tools to visualize the trend and spot potential reversal points. Traders, however, usually don’t draw them properly. They try to make the market fit the line, instead of making the line fit the market. This misuse of trend lines often results in major losses for traders.
It’s easier than you think.
This article will help you understand what trends are and how to recognize them. We will then explain how to properly draw trend lines. Finally, we will see how to use trend lines, which will definitely help you become a more profitable trader.
1. What Is A Trend And How To Recognise It
While building a comprehensive trading plan, it’s important to know about the different ways to analyze the markets. Fundamental Analysis, Technical Analysis, and Sentiment Analysis are the 3 main types of market analyses.
So what’s it all mean?
While Fundamental Analysis will help you to decide in which assets to invest, technical analysis will help you to determine when. As we will see, the concept of the trend is the cornerstone of Technical Analysis. Trend lines are therefore essential tools to correctly analyze the markets and invest in a more solid way.
Fundamental Analysis vs Technical Analysis
Fundamental Analysis is about understanding the economic forces that impact the supply/demand relationship of an asset that will cause prices to move. Technical Analysis, however, studies the effects – not the causes.
The technical approach is based on 3 premises:
Market action discounts everything, history repeats itself, and prices move in trends.
Technical Analysis will then look at past market movements to predict future prices trends.
The concept of a trend is then essential to technical analysts. They will often read charts with the sole purpose of identifying trends. They will especially focus on recognizing a trend’s early stages, so then they can trade trends while they develop. This method is called trend trading.
Trends according to the Dow’s Theory
Even though Charles Dow never published a book while he was alive, he set down several ideas about the stock market, which were published in The Wall Street Journal. Nelson, S. A. then compiled these editorials in a book called The ABC of Stock Speculation. It’s only then that the term “Dow’s Theory” was invented. It refers to several basic tenets that technical analysts use to study the markets. Let’s focus on 2 of these basic tenets here.
Most traders believe that the markets only evolve upward or downward. However, markets can also trade sideways. This lateral consolidation happens when market participants are undecided, which occurs about 1/3 of the time. Dow defines an uptrend as situations where prices form higher highs and higher lows. Conversely, a downward trend is defined as a pattern of falling peaks and throughs.
Each trend is also supposed to have 3 different parts: a primary trend, a secondary trend, and a minor trend. The secondary trend is a corrective movement within the primary one and lasts from 3 weeks to 3 months. The minor trend is a fluctuation within the secondary trend and usually, lasts less than 3 weeks.
The Phases Of Trends
Dow focused his work on major trends and explained that they often take place in 3 phases. First, there is the accumulation phase, followed by a public participation phase, followed lastly by a distribution phase.
Let’s imagine that we’re following a particular stock, that’s beginning to come out of a downward trend:
The 1 st phase begins with experienced traders. They will notice a stock, recognize that it’s hit bottom, and buy while it’s still good value.
The 2 nd phase happens when other traders, who are perhaps less experienced, enter the markets. This is when most technical trend following analysts enter the markets. Usually, market prices will accelerate and the news will be more positive about a given financial asset.
The last stage takes place when the news is extremely positive and bullish on this asset. The same traders that went bullish on the asset while no one wanted to buy it now start to sell it before anyone else.
2. What Are Trend Lines And How To Draw Them
Trend lines will help you to spot areas on a chart where the supply/demand for a given asset has increased.
The above chart shows first an uptrend line on the EUR/USD currency pair. The uptrend line has a positive slope connecting low points, with multiple connected points ascending upwards. Uptrend lines play the support role – as long as prices are above them, the bullish trend is intact.
To sum up:
A trend line is a straight line that connects several points on a chart, which can be used to both establish trends, and to forecast the future direction of a given asset, with trend lines acting as a support/resistance lines. The trend lines show zones where the forces of supply and demand meet and push prices to move.
A support level is a level where the demand for an asset is stronger than the selling pressure, preventing prices from falling further.Conversely, a resistance level is a threshold at which selling pressure is greater than buying pressure.
How To Correctly Draw Trend Lines
If there is an uptrend, the 1 st thing to do is to draw an ascending support trend line. Conversely, if there is a downtrend, you should draw a descending resistance line. If you draw an ascending resistance trend line with an upward trend, you won’t get any relevant information. You can only see a potential change in the current trend with an ascending support line. This line will indicate that the previous bullish movement is no longer valid.
Here are other important criteria to take into consideration when using trend lines.
- Time frames – Higher time frames will always produce the most reliable trend lines.
- Validation – In geometry, you need 2 points to draw a line. In Technical Analysis, you need 3 points to draw a trend line. The more points touching the line, the more solid and valid the line will be.
- The spacing of points – The points used to draw the trend line shouldn’t be too close or too far away from each other.
- Overlap – Highs and lows from candles will sometimes overlap with the trend line, but it’s important to have the bodies of candles touching the trend line.
- Psychological Reaction on the Line – The points of contact should always trigger a price reaction. A psychological reaction from market participants should then always happen in contact with the line.
- Angles – The steeper the trend line, the weaker its validity will be. A very steep trend line usually shows a sharp price advance/decline, which will not offer meaningful support/resistance levels.
3. Using Trend Lines To Make Profitable Trades
On the below chart, you can see that the price had followed the ascending support trend line for a number of years. Every time prices touched the trend line, you could have reliably opened a long position and traded with the trend. Trend lines are also useful tools to detect potential reversal points.
After an upward acceleration, prices eventually lost momentum: the highs and lows became lower and lower. Once prices broke the trend line with a long red candle (bearish marubozu), they retested the former support. This level then became a new resistance level, as highlighted in the rectangle of the same chart. This is called a pullback. This retest gave you a perfect selling trading opportunity to make profits.
As you now understand, trend lines are useful trading tools to implement in your investment strategy, as they can help you to make more profitable trades. When prices touch a trend line, it gives you an opportunity to enter the markets with the main trend. When price breaks a trend line it is usually with higher trading volume. Potential buying or selling trading opportunities will appear once a trend line is retested after being broken.
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