Following trends is one of the most effective ways of creating winning forex trading strategies. Trends reveal the direction of prices in the market over a given period of time and can move upward, downward or sideways. Trades can also take place in different time frames, from long-term to short-term, and there can even be smaller trends that can be detected within a longer-term trend. Trends can be identified by charting price data in forex charts and then looking at the direction in which they are moving. It should be noted, however, that just because prices are trending in a particular direction does not mean that momentarily reversals do not happen, merely that during a certain period of time, the price will move in that direction more often than it reverses.
When creating forex trading strategies by following trends, the basic thing to remember is that you will have to enter the trend early and hold on to your position until you detect signs that the trend is reversing, then close your trade. In order to avoid losing too much money while pursuing this trading strategy, traders typically set their stop losses close to their entry price. While there is a possibility of high drawdowns when pursuing this strategy, you can also make high profits if it is implemented properly.
To successfully implement trend-based forex trading strategies, you will have to learn to identify trend reversal patterns in forex charts. When prices break out of these patterns, it is a sign that the current trend may undergo a turnaround. The most common trend reversal patterns are:
- Head and Shoulders. This pattern is so-named because it has three peaks that resemble a person’s head and shoulders. The support line for all three peaks is known as the neckline and when the price penetrates this line, it is a signal that a reversal is due. To confirm that a reversal is due, however, the trader should check if the price momentum was greater when the left ‘shoulder’ was formed since it confirms that a reversal is happening.
- Inverse Head and Shoulders. This pattern is the opposite of the Head and Shoulders but the peaks appear below the neckline. In this case, the price breakout will be in an upward direction.
- Double Top. In this reversal pattern, the price rises until it encounters a resistance level and then falls to a support level, which is the neckline, and then repeats the movement. Once the price of the currency fails to breach the resistance level a second time, it will fall and breach the neckline into a new downward trend although it may momentarily test the neckline.
- Double Bottom. This is the opposite of the Double Top but instead of pursuing an uptrend it follows a downtrend until the trend moves upward again, although occasionally it may also retest the neckline.
Since using trend-based forex trading strategies can be highly risky, particularly since the trader is using high rates of leverage, it is advised that the trader use money management strategies not only to prevent losses but also to safeguard their profits.