In the financial markets, prices can be found in three states: trending up, trending down or trading in a range. Each market condition requires a different approach. There are specific indicators and strategies developed by traders for trading ranges and trends. What’s more, each trader has a unique fx trend trading strategy that best fits his/her personality.
There are many trend trading strategies, indicators and chart patterns. When developing your own trend trading strategy in fx trading, it’s best to learn about the different strategies. Get informed as much as you can, create your own plan and test it before going live. There are a million ways to make money trading financial securities. Unfortunately, all of them are very hard to find as there is a fierce competition. It’s critical your trading strategy to fit your personality for the process to remain sustainable. Traders that like to spend more time on analysis and planing, choose strategies that enable them to position trade. Traders that have fast fingers and make up their minds quickly, day trade or news trade.
In this guide, we focus on various trend trading indicators and strategies. In addition, we explain what trend trading is and what special features the process has.
Core features of trend trading in forex
- Trend trading patterns and indicators help traders join already established or brand-new trends
- Trend trading is recommended for novice traders, as placing orders against trends requires skills and experience
- Every trend trading strategy Forex traders use is built on the idea that following trends increases the likelihood of success. These strategies only work in suitable market conditions
- Indicators such as Moving Averages, Bollinger bands, ADX and MACD are some of the most frequently used indicators in trend trading
- Using stop losses is critical in trend trading to limit downside risk. In general, traders get a good idea where to place Stop Loss (SL) orders, however, Take Profit (TP) targets are not always clear. Often, TP placement depends on how the trade develops
How does trend trading work in FX?
In simple words, trend trading involves joining price trends. Fundamental factors make markets move. FX pairs move based on trade deficit, interest rate decisions, unemployment numbers, building permits, inflation, etc. While fundamentals give general direction, technical factors such as indicators, patterns, significant levels, etc. create a frame for the prices to move.
When price starts moving from A to B point, it doesn’t happen in a straight line. In financial markets, prices move in waves. Price goes to a certain direction and then retraces, goes again and retraces again. The retracements are used by trend traders to join trends. Some traders use simple trendlines while others use indicators to spot trend joining opportunities.
Trend trading is recommending for novice traders, as following strong trends is much safer than trading against them. The process is not without risks, as prices can reverse at any moment. Each trend trading strategy for fx traders should include a Stop Loss order. Often traders make that mistake and trade without stops. When price goes against prediction, they start hoping the price will reverse, and they’ll be able to get out of the trade at breakeven. This approach might work a couple of times, but ultimately will result in a blown up account.
Trend do not last forever. Especially when trading Forex. Forex markets have more cyclical nature, as one currency is always valued against another currency. Currencies are backed by real economies, governments and people. Consequently, chances of a currency pair’s price reaching zero or rising to the moon is limited. The situation is different for stock market. Companies can get bankrupt much easily and the stock price can become 0. Or stock prices can grow without limits due to the fact that more money is printed every year.
The most difficult part when trading trends is measuring how long can they go. Often traders have very good idea about SL placement, but TP targets are unknown as they depend on how trade develops. If we have a strong trend, getting out of the position too soon will be a mistake. Every well put together trend trading strategy in forex has a plan on how to manage profitable trades. Traders use various indicators, simple trendlines and patterns to time their exits. In this regard, volume indicators are highly useful. When you join a trend, you want a high volume, as it indicates that traders are interested in the trade and there’s an energy to make the price move. On the other hand, when volume decreases, it might be a sign of lost interest and price might reverse. Simple trendlines are highly effective too. Trendlines are used as support and resistance lines and as they break, traders get out of active positions. No matter which strategy you prefer, it’s critical to never run your losses. Successful traders run their profits and cut their losses fast. It’s much better to take 20 pips loss than to risk half of your trading capital.
As already mentioned, TP targets are not always visible when trading trend. Stop loss orders are usually placed below retracement. The size of the trade depends on the setup. Professional traders typically never risk more than 1-5% of their trading capital per trade. If the setup is perfect, the risk can be around 5%. If it’s not, around 1% or less. High frequency traders place multiple trades per day, and consequently, their risks are much less per trade than of position traders’.
A typical risk/reward ratio advisable to forex traders is 1:1 or higher. If you are using 1:1 risk to reward ratio, your success rate needs to be higher than 50% to make money consistently. If you are only correct in your predictions half of the times, your rewards need to be greater than 1 for every 1 risk ratio.
What’s great about using a great fx trend trading strategy, is that, traders usually get amazing risks to rewards. When you are in a strong trend and price jumps in your predicted direction sharply, you can simply move your stop loss and trade risk-free.
Bollinger Bands is a technical indicator that shows how volatility affects the market. Bollinger Bands is a trend trading indicator that consists of three lines or bands. The middle band is a simple moving average and can be used as a support and resistance line. 95% of the time the price is inside the rest of the two lines. The idea is that, when the lines shrink, volatility decreases and traders can join trends. The increase in volatility widens the bands.
Moving Average convergence/divergence (MACD)
Moving Averages find the average price of an instrument over a specific time period. Moving Averages can be used to compare present prices to average performance. MACD is a lagging indicator, which means it shows past performance and makes it easier to digest visually.
MACD can show whether the market is moving up, down or sideways, which is brilliant for identifying trends. Many trend traders use two exponential moving averages, or EMAs, to find points on the market which indicate an uptrend or downtrend. Traders can add two EMAs to a chart, with one being slow (using a longer period as sample) and the other being fast (using a shorter period as sample). Where the two EMAs cross can indicate a coming uptrend or downtrend.
The GBP/USD chart illustrates all the points where slow and fast EMAs cross:
- When the fast EMA crosses the slow one from below, traders can enter a long position
- When the fast EMA crosses the slow one from above, traders can enter a short position
Average directional index (ADX)
The average directional index, or ADX, is a technical indicator that measures the strength of a prevailing market trend on a scale of 0 to 100. Anything below 25 is considered to be a weak trend, while an ADX figure of over 75 would indicate a strong trend. ADX is often paired with the directional movement index, or DMI, which includes the negative (-DI) and positive (+DI) directional indicator lines.
On the GBP/USD chart, we can compare the -DI and+DI values and see where they cross.
- If +DI crosses -DI above 25, this can indicate a coming uptrend
- If -DI crosses +DI above 25, this can indicate a coming downtrend
Pros and cons of trend trading in forex
- Trend trading is easier than trading against trends
- There’s an unlimited profit potential once in a trend and profits depend on the strength of a given trend
- There are many indicators and patterns developed for helping trade trends
- Trend trading strategies tend to have less clear profit targets
- Markets are keep changing from trends to ranges and trends again, which makes it difficult to know exactly when to trade trends
- Requires significant active involvement from traders for finding opportunities and managing active trades
- False breakouts happen frequently on the market
- Requires the understanding of multiple technical indicators for effective implementation
Example of trend trading in forex
To examine the use of technical indicators in trend trading, we can look at the trend trading strategy example. In this YTD chart of GBP/USD, we can see the technical signs that indicated the depreciation of the pound against the US dollar.
The ADX shows the crossing of +DI and -DI at points above 25 that indicate an uptrend. This was especially evident after the pound fell to its lowest at 1.0697, which the RSI also indicates as being considerably oversold – prompting traders to start buying at the 1.07-1.08 area.
FAQs on trend trading in FX
Does trend trading strategy still work?
Trend trading has become popular the moment financial markets opened for trading. Trend trading is a safer way to generate profits for novice traders, as trading against trends requires more skills and experience. There are various trend trading strategies developed for Forex traders. Each trader needs to find a trend trading strategy in Forex that fits his or her personality.
Can you get benefits from trend trading strategy?
Forex trend trading strategy can be highly beneficial as often when following trends, traders have fixed risks and unlimited reward potential. Usually, traders can easily spot where to place stop loss orders, but the take profit order placement typically depends on the strengths of a trend.
What is risk-reward in trend trading strategy?
Risk to reward ratio is dependent on the trading setup. Typically, trend trading strategies offer good risk to reward ratios. On many occasions, traders have a clear idea where to place their stops, but profit targets depend on how the trade will develop. Generally, traders use trailing stops, simple trendlines, and volume indicators to get out of trends. Ideally, traders stay in the position as long as trends continue to maximize returns.