At an early stage in their development FX traders will confront an important issue; whether to trend trade or range trade? Trend or range trading are two distinct methods requiring opposite mindsets and money-management techniques. The FX market accommodates both styles, providing trend and range traders with opportunities for profit.
Tom Basso, in the book Trade Your Way to Financial Freedom explains the simplicity of trend trading simply and effectively;
Let’s break down the term Trend Following into its components. The first part is “trend”. Every trader needs a trend to make money. If you think about it, no matter what the technique, if there is not a trend after you buy, then you will not be able to sell at higher prices. “Following” is the next part of the term. We use this word because trend followers always wait for the trend to shift first, then follow it..
In part one of this two part series we’ll discuss trend trading, sometimes referred to (arguably confused with) swing and or position trading. In many respects the Forex market is custom built for trend followers. Long term directional movements can be obvious to witness in the major currency pairs, trend followers attempt to capture these moves. This article will describe trend following but will fall short of recommending any particular strategy or methodology. Instead we’ll concentrate on how trend trading can be implemented in the Forex market, we’ll highlight the potential pitfalls, and ultimately illustrate an example of what successful FX trends and range trades can look like.
Spotting the trend early and riding it until the end is the Nirvana for trend, swing and or position traders, unfortunately, as with most aspects of trading methods, the reality is rather different. When novice traders step up to swing or trend trading their first issue is taking on board the bigger stops required, this shouldn’t necessarily mean more risk, the risk should still be kept down to 1-2% of the account, however, this also sheds light on another more prevalent issue. In order to swing/trend trade effectively (and potentially draw down a reasonable income) the trader will undoubtedly need to operate from a bigger account.
If the individual trader has, for example, a €30,000 euro account and requires €3,000 income per month then they’d have to enjoy returns of circa 10% per month, just under 0.5% return per trading day to achieve this income. This is by no means a ‘pie in the sky’ or impossible target. Many would point to the fact that this would be circa 120% return per year (before compounding), a figure that legendary figures such as Warren Buffett and George Soros would pay handsome retainers for therefore many opposing traders suggest that return on a swing trading account is unachievable, but that ignores how straight forward it can be for trend or swing traders to ply their trade vis a vis institutional traders.
Stops When Trend Trading
When placing stops the ideal place has been determined as the highest high or lowest low of the session. The alternative is to place the stop where the trader envisages the turning point of price to be, others may choose an aggregate based on their experiences, perhaps a nominal 150 or 200 pip stop which can be trailed. What is for certain is that the stop will be much wider therefore once the position size is adjusted the lot size must be radically reduced to remain in the 1-2% risk parameters.
Price And Only Price Is Your Indicator
There is a belief amongst a certain element of trend traders that price is everything, it’s the only overpowering metric when making trading decisions. Trend traders could (in theory) ignore all fundamental data if they’re of the opinion that all information is inherent in price itself and that price, in the form of; price action, pattern recognition, or indicators will eventually be represented on the chart.
Trend following is an investment strategy that tries to take advantage of long-term moves in the FX market. The strategy aims to take profits from both sides of the market, enjoying the profits from the bullish or bearish environment of market. Traders who use this approach can use current a market price calculation, moving averages, indicators, pattern recognition and channel breakouts to determine the general direction of the market and to generate trade signals. Traders who employ trend following strategies do not aim to forecast or predict specific price levels; they simply identify the trend, jump on the trend and remain with it until in their opinion the trend is exhausted. Trend following is a trading strategy that tries to take advantage of long-term moves that eventually manifest in the FX market.
Waiting For The Trend To Develop
Traders who employ a trend following strategy don’t aim to predict specific price levels. These traders usually pull the trigger once the trend is established itself, betting that the trend will persist for a long time, for this reason, they tend to overlook what traders using ‘range’ strategies would term to be the initial turning point. A market trend is a tendency of price to move in a particular direction over time. If there is a turn contrary to the trend, trend traders exit and then wait until the ‘turn’ establishes itself as a trend in the opposite direction. If their rules signals an exit, the trader exits but then re-enters when the trend re-establishes. The trader will exit the market, in order to minimise losses, when price turns (and direction) versus them. “Letting the profits run”, when the market trend goes as expected until the market is in the opinion of the trader is exhausted and reverses is an impossible phenomena to identify one hundred percent of the time, many traders will use a hard and fast rule, by way of indicators and or a reversion to the mean, in order to exit. Waiting for the trend to completely exhaust can often see the handing back of too high a percentage of the trade profit.
An initial risk rule should determine the position size at time of entry. Exactly how much to buy or sell is based on the size of the trading account and the volatility of the issue. Changes in price may lead to a gradual reduction or an increase of the initial trade. If adverse price movements are experienced this may lead to an exit for the entire trade.
One of the first rules of trend following is that price is everything. Trend traders often use indicators showing where price may go next, but as a general rule these are often disregarded. Swing or trend traders often concentrate singularly on where price is now and not what the market might do. The current price (and only the price) tells you what the market is doing.
Another decisive factor of trend following is not necessarily the timing of the trade or the indicator set used to pull the trigger, but moreover the decision of how much to trade over the course of the trend.
During periods of higher market volatility trading size can be reduced. During losing periods, positions are reduced and trade size is cut back. The main objective is to preserve capital until more positive price trends reappear.
Trend following should be systematic. Price and time are critical at all times. This technique is not based on an analysis of fundamental supply and demand factors.
It is possible that a majority of the trades may be unprofitable and this is an extremely difficult concept for many new to trend and swing trading to take on board, but by “cutting the losses” and “letting profits run”, the overall strategy can still be profitable. Trend trading is most effective for a market that is quiet (relatively low volatility) and trending. For this reason, trend traders often focus on commodities and FX, which shows a stronger tendency to trend than equites.