How to Profit from Trend Trading
Retail Forex traders have two things going for them that they can use to grow their trading accounts, both of which can be easily identified by using freely available price charts. The first factor is the trend: locate currency pairs or other instruments that are trending, and trade only those pairs/instruments, in the same direction as the trend. The second factor is picking good trade entry points within those trends. This article will show you how you can succeed at doing both and profit from trend trading.
How to Find Trends
You can find all kinds of complicated indicators to tell you when there is a trend. These indicators are usually based around moving averages or similar indicators. While these indicators can work, most traders use them incorrectly. Worse, they’re not even really necessary! There is a very simple way to determine whether there is a trend and the only tool you need is the ability to count. Just ask yourself: is this currency pair trading HIGHER than it was or LOWER than it was? That’s it! That is all you need. If it is trading higher, there is an upwards trend, and you should look for long trades. If it is trading lower, then there is a downwards trend, and you should look for short trades.
As you are probably already asking yourself, trading higher or lower than WHEN? I like to use two filters that have historically worked well, especially with USD and EUR currency pairs: a comparison to historical prices from both three months and six months ago. For example, if I look at USD/JPY, I ask myself whether the price is higher than it was both six months and three months ago, or lower than those historical prices. This tells me whether to look for long or short trades, or to not trade that currency pair at all if the price is somewhere in between.
You can also use this to measure how strong the trends are. For example, if the price is just a tiny little bit higher than its prices from three and six months ago, then technically you have an upwards trend, but it is possibly not a trend you should be be very confident in. The best trends will show a price something like more than 2% away from its price of three months ago, and further still from its price of six months ago.
So by doing this pretty simple analysis on your charts – just by looking at a few different prices – you know which pairs to trade and in what directions. Now it is time to consider how to best pick your trade entries.
How to Pick Trade Entries
The first thing to know is that by only trading in the same direction as solid trends, you have won more than half the battle. Trading with the long-term trend is more important than the exact entry strategy you use. Too often traders focus exclusively on the tricks of entry. Entries are important, but trading with the good trends is more important!
The best way to enter trades in Forex is to wait for a pull-back (a move against the trend). Then, enter in the direction of the trend once the price has begun moving in the direction of the trend. This gives better overall results than trading breakouts (overtrading breakouts is another common mistake).
One way to execute this is to wait for the price to make a new 24 hour low in an uptrend, or a new 24 hour high in a downtrend. By definition, these will be pullbacks. One you have that new high or low, wait for the price to turn around back into the direction of the trend and make a new 4 hour high or low. This is your entry trigger. You can place a stop loss order just below the other side of the 4 hour chunk of price. I suggest 4 hours as this seems to work well as a compromise between getting in early enough to have a fairly tight stop most of the time – important for achieving good reward to risk ratios – but late enough for the movement to have been meaningful. Quite often, you will find that better entries tend to be from 4 hour price ranges that are at least as big as the average range of 4 hours of price action.
One important thing to emphasize here is that the entry should be triggered within 4 hours from the initial set-up, otherwise the trade should not be taken. This way, you stick to trades that show some initial momentum. Of course, if the stop loss level is hit before the entry is triggered, you wait for another 4 hour chunk of price to form a reversal back into the trend.
Refining Trade Entries
You should be able to make money just by following this plan or something similar to it. However, as with all rigid systems, there are going to be losing streaks of several trades in a row. You might be able to improve that situation, but it can be a challenge for newer trades. Nevertheless, here are a few tricks that can improve performance:
You will get better trades if you only take the entry set-ups that are also completing major double or triple top formations, or over and under formations, i.e. set-ups that are confluent with fairly obvious support and resistance. However, if there is a really incredibly strong and “runaway” trend going on, you do not need to worry about that and can just take every entry.
The best trades tend to go into profit pretty quickly.
It is best not to try to be too smart about exits. Aim for about twice the risk on each trade. You can either set the target or aim for an obvious support or resistance area which is at about that distance from the trade entry point.