The Encyclopedia of Trend Trading in Forex
Trend trading remains an essential strategy most retail traders use in the financial market. The forex market moves in trends, which is a remarkable behavior of the financial market; before we dive into trend properly, there are vital concepts to understand first.
However, it is paramount to buttress that trend trading isn’t guessing about the direction of the market. Instead, it is about allowing the market to do its thing while you react based on what is happening. With this, your trading becomes based on statistics and probabilities, rather than depending on your feeling or gut. Trend trading is the foundation for success in the forex market.
At the end of this article, you will discover essential tools to know when the market is trending; at the end, questions such as how strong is a trend? When to exit a trade in a trend? How long a trend will last will be answered. Take a seat and enjoy the ride towards trend trading.
What is trend trading?
A trend is a fundamental principle of technical analysis; this remains true because of price moves in three ways – uptrend, downtrend, and sideways (we will talk about this later). The purpose of a technical trader is to find early entry point during a trend and exit once the trend is about reversing. A chartist uses trend lines, moving averages, and other indicators to anticipate the direction of a trend.
Technical analysis involves the use of charts to predict future price movements. Technical analysts are focus on studying charts while identifying trends. Identifying trend helps in identifying the demand and supply of a particular asset. However, technical analysis is built on three assumptions
Assumptions of Technical Analysis
- Market discounts everything – Does the statement meant anything? What it means is that all factors have been taken into consideration, whether psychological or fundamental. Therefore, the factors should change the dynamics of supply and demand in the market.
- Prices move in Trends – The idea behind studying charts is to find trends. One important statistics that all traders won’t forget like reading the alphabet is “the trend is your friend.” Going against the trend is a bad experience you don’t want to have.
- History repeats itself – Even in our daily life, some things replay themselves. Have you ever thought that what is happening now has happened some time ago? Yes, history also repeats itself in the forex market. Traders have a mindset that once the price gets to support levels, they should buy whereas sell at a resistance level.
Trend trading and Swing Trading
For new traders, it is common to confuse trend and swing trading. Well, both strategies use involves trading trends. Nevertheless, the difference lies in the approach to the strategy. For instance, swing traders focus on the movement of price from a cyclical high to low or vice versa, whereas trend trading ride out the recurring highs and lows provided the trend is ongoing.
A trend occurs when there is a progression from recurring highs and lows or vice versa. The progression gives yield to uptrend and downtrend; a downtrend is a series of lower highs and lower lows; an uptrend is a sequence of higher highs and higher lows.
Swing traders are concerned with capturing smaller swings within a trend. With this, they can generate a high profit. Swing traders sell at a higher price while buying back when the price falls below. As simple as it sounds, it can be difficult to generate much potential even though the potential for profit is high. Because of this, most traders implement both methods of trading to generate higher returns on trades.
Types of Trend
Trends are of three types, with each having its distinctive ways of trading. Price can move in only three directions – upward, downward or sideways.
- Uptrend – a market is in an uptrend when it is making higher lows and higher highs. In other words, price is moving in an upward direction irrespective of the timeframe. Most traders, when observing that the market is making higher lows and higher highs look at for opportunity to buy at the area of higher lows.
- Downtrend – A downtrend is the opposite of an uptrend; here price is reaching higher lows to lower lows, thereby giving sellers an advantage over the market. To sell in this situation, traders look at the higher lows region to enter a sell trade to catch the downward trend.
- Sideways or ranging – Statistics have shown that about 70 percent movement in the market is a ranging phase. In this phase, price is merely consolidating and can be a continuation or reversal pattern. For newbies, this kind of market is a tricky one and quite easy for professionals to identify the direction.
Timeframes for Trend Trading
Since you understand the concept of trend trading, another critical element to trading it profitably is the timeframe. A trend can occur in a day, weeks, or months. Such a trend can be short-term, intermediate, or long-term. Theoretically, a short-term trend involves price moving from a few days to a few weeks. The intermediate trend ranges from six weeks to nine months while a long-term trend can go from nine months upward.
Putting this into consideration is critical since it helps traders identify the best period settings for the indicator of their choice. Most traders trade the trend on a daily chart, which is a short-term trend.
Best Indicator for Trend Trading
Another issue for trend trading for beginners is the challenge of what indicator to use. While there are numerous default and custom indicators available to spotting trend, the accuracy of these indicators is another major issue. Here, we will look at the moving average indicator for trend trading. Importantly, you shouldn’t limit yourself to this indicator because there are other indicators for trend trading.
By far the most used indicator for trend traders because it identifies trends by the successive movement of price from highs and lows. For beginners, it is the best indicator since it makes their system less discretionary.
The two most common moving averages for traders are the simple and exponential moving averages. The simple moving average places weight on each closing price over a period chosen, whereas the exponential moving average places greater weight on the most recent price.
The simple strategy followed by most traders when using moving averages to trade trend is crossover. The strategy involves opening a long position when the smaller moving average crosses over the longer moving average. For instance, you have 30 MA and 50 MA; whenever the 30 MA crosses over the 50 MA, traders look for opportunities to buy. Alternatively, when the 50 MA crosses over the 30 MA, traders can go short.
Trend Trading Strategies for Forex Market
For the beginners, it always a daunting task to find a strategy that is quite easy to implement when trend trading. However, the strategies here are the best you will ever find in the forex market. Following them judiciously, you can make a profit before becoming a professional.
Professional traders rely on trends and stick to it as their only trading strategy. Now you have the opportunity to learn what can change the course of your life. However, there are criteria that a trend following strategy must have; you should look at these things before placing a trade.
- Identify an emerging trend
- Identify both the entry and exit point
- Identify trend reversal
- Understand technical and fundamental analysis
Then bear in mind the following things
- Wait for confirmation before entering a trending market
- Have a strategy for uptrend, downtrend, and ranging market
- Record your trades
- Implement a risk management plan
- Always use stop-loss
Are you ready for the trend trading strategy?
Most traders haven’t harnessed the potentials of the Bollinger Bands; you will surely get the best out of it after reading this. Bollinger bands assume that price will bounce back whenever it reaches the upper and lower bands; it acts as an elastic band.
The Bollinger bands indicate the price highest and lowest point in the market; its usage cut across various periods of the market – uptrend, downtrend, and ranging market. The Bollinger band helps to measure the volatility of the market. The idea is that once the bands are far from the current price, then it is in a volatile market.
However, if you haven’t backtested it and confident about it as a trader, you should consider not using it. Furthermore, Bollinger bands serve as a good trend trading strategy; you sell when the price reaches the higher Bollinger band and buy when the price touches the lower band.
Average True Range
The ATR is another less used indicator for trend trading because most people don’t understand the basic concept about it. The indicator measures the volatility in the market; the larger the candlestick on the chart, the larger the ATR. However, the indicator doesn’t tell the direction of the trend. The ATR indicator rises whenever a bull or bear market emerges. The trader uses his or her discretion to differentiate a bullish or bearish market; it is important because the indicator can’t differentiate a bull or bear market.
How then do traders use the ATR to trend trade? The strategy involves a simple rule – low volatility always follows high volatility and vice versa. Putting that into consideration, whenever price gets to a historical high, it means a break is inevitable.
Bull and Bear Flags
The bull and bear flags work opposite to each other. For a new trader, it can be hard to identify them unless you have studied candlestick patterns and formation. The bull and bear flag is mostly formed when a channel pattern is applied to them. The lower part represents the flag pole, whereas the channel lines represent the flag. In a bear fear, price tends to be on a decline whereas in a bull flag, it is on the rise. The bull and bear flag can be incorporated into whatever trend strategy you decide.
Head and Shoulder
The head and shoulder pattern is a famous trend trading strategy that symbolizes that the current trend has ended; it also shows that one new trend is emerging. The name is derived based on the shape they form; they have the look of a person with head and shoulder.
Additionally, the head and shoulder can form an upside or downside. The shoulders can be two lows or two highs, whereas the head is the highest or lowest point of price. Traders look for an opportunity to short when it is in an upright position. Alternatively, traders go long when the head and shoulders get formed in an upside-down position.
Risk Management in Trend Trading
Whatever strategy you decide to use, risk management is an integral part of trading. As a trader, it is effective means of improving your success rate. One crucial risk management strategy to implement is to use stop-loss on all trades. Without reasonable risk management, you stand to lose your capital since the market is volatile.
Trend Analysis Limitations
Critics of technical and trend analysis believethat the market itself is efficient and contains every information any trader needs. They believe that the assumptions of technical trading are baseless. However, for enthusiasts of fundamental analysis, the best approach is to use the financial condition of companies to predict the market. No matter what side of the fence you are, the most important thing is to make a profit while trading.
Conclusion Of Trend Trading
Trend trading is a priceless approach to trading,primarily when fully understood. For traders, incorporating trend trading into their strategy is essential to generating quality signals.
The expression “the trend is your friend” is a general statement for both technical and fundamental traders. Trend trading is profitable for a trader that understand the concepts. However, there are various means of identifying trends because that is what will help a trader make a profit. Indicators such as moving averages, average true range, and Bollinger bands enable traders to know if a trend is about to form or not.
Finally, any good strategy must include a risk management plan because that is crucial to your success in trading. While you implement these strategies in this article, ensure you backtest and confident of their outcome.