Long term directional movements are obvious in the major currency pairs and Trend Following captures these moves.
This article describes the Trend Following strategy, shows how it can be applied to the Forex market. We talk about the pitfalls and benefits of the strategy, and show an example of what successful Forex trend following looks like.
Traditional Trend Following teaches buying new highs and selling new lows is how to enter the market. Other schools of thought try to fine tune the traditional method by buying pullbacks on shorter time frames within the overall longer term uptrend.
Trend Followers usually believe that price is the only thing that matters when making trading decisions. They tend to discount fundamental data, believing that all information is inherent in price itself.
In fact, some famous Trend Followers even go as far to say that price makes news, not that news makes price. Remember, simply reverse these rules if you wish to enter short within a down trend. Here are the steps to follow to trade with the traditional Trend Following method:
Ascertain trend— which way is the pair moving? Take a look at a several year chart; is it trending up or down? Let’s assume your chosen pair is trending up.
Pick your entry point— the best way to enter a trend trade is hotly debated.
As stated earlier, traditional trend traders will buy whenever a new high is reached. Others will wait for a pull back to the Moving average, or a pull back within a shorter time frame chart.
Patiently wait-- for the trend to continue carrying your position into profits. This is the hardest part for most traders. Trend Following is a slow, grinding trading process.
Exit the trade----Wait until the trend appears to have changed totally prior to exiting. This is another nebulous trend following rule. The question if this is just a correction or an actual change in trend is a difficult one to answer in real time. However, it looks like an easy one in hindsight. One needs to follow strict rules concerning exits when Trend Following.
Discipline is critical for this strategy.
What we like is a combination of Trend Following and fundamental/news research as a trading strategy.
We don’t believe that pure price is enough to make proper trading decisions in the Forex market. With this said, Trend Following has its place as part of a complete strategy, not the total strategy.
Trend Trading obviously works in the Forex market; however it’s harder than it looks. Large corrections are an inherent part of the strategy.
The Forex market has severe intraday swings that will knock out all but the very committed, disciplined trend trader. Determining which corrections are actual changes in trend can’t be known until after the fact.
Therefore, a strict set of rules and strong discipline are a must to make money Trend Following.
Perspective is one of the most important rules you can set. Alongside trend are timescales.
Is your strategy hourly? Daily? Weekly? Monthly? Or even longer?
Dependent upon your strategy and timescale look at only the charts that pertain to the period you use when making a decision to enter a trade. Use other periods for verification and also to confirm the strategy.
For example, the Euro currently appears to be in a long term downtrend against the dollar. However, on a weekly or even monthly basis the trend could be up drawn by a long term downtrend line. As we say above, use of fundamental research and analysis goes hand in glove with a Trend Following strategy.
Trends can easily form “in the mind”. That is to say the trader believes that a certain currency pair is in an uptrend or downtrend when the reality is otherwise. This is often true of the dollar. When the economy is suffering, it is natural to “feel” that the currency is trending lower but taking a look at longer term charts shows the opposite or vice versa.
In summary Trend Following is a useful strategy but not used in isolation. This is of course true for everyone but the most rigid and determined trader.