Among the many types of trading strategies that exist, including things like counter-trend, channel, breakout, and scalping strategies, trend-following trading remains one of the most popular among private independent traders – and for good reason.
There is a popular saying that the “trend is your friend.” While this is generally true, it’s important to understand how to determine trends and when to enter the market. Otherwise, the trend might just become your enemy! Let’s take a closer look at what trend following trading is, and how you can implement this tried and tested methodology in your own trading.
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How to determine trends worth trading
The first step in any trend strategy is to define the trend. This can be done both visually, by simply looking at the chart, and with the help of technical analysis indicators to support the initial findings.
One of the most important things in defining the trend is to check the higher timeframes, which will give you a more general view of the market situation. For example, if you trade on the 1-hour chart and determine a strong bullish movement in the price, make sure to check the 4-hour and 1-day timeframes. The uptrend in the 1-hour chart may be just a short-term correction of a bearish trend that can be seen when looking with the larger timeframes—the big picture. Otherwise, you might find yourself trading against the trend rather than following it.
Basic forex indicators
Technical indicators make it easier both to determine whether there is a trend in the first place, and also understand the intensity and strength of the trend. If you trade on the MT4 platform, you’ll find a whole section dedicated to “trend” indicators. We’ll discuss two of them: Moving Averages and Bollinger Bands.
Forex moving averages
Moving Averages (MAs) are probably among the oldest and most popular technical indicators we have in trading. What’s also interesting is that MAs are the building blocks of many other trend indicators and oscillators.
The principle behind a MA is simple – the closing prices of an asset are added together and then divided by the number of periods we are calculating for. This strategy forms an average that always moves as new closing prices are included in the calculation. Thus, if we want to check the 5-day MA of EURUSD on the daily chart, we’ll have to add the closing prices of the pair during the last five trading days, and then divide that number by five. So far, it’s simple math!
Using MAs in trading is essential because they have the ability to smooth out erratic price action, and help traders filter out the noise caused by short-term ups and downs in the market.
There are two main types of Moving Averages: Simple Moving Averages (SMA) and Exponential Moving Averages (EMA), with the latter adding more weight to recent price movements, which makes EMAs more “sensitive” to changes in price. Here’s what the moving averages look like on a chart:
On the chart above, we have two MAs: the red line represents the SMA with period 9, and the blue line is the SMA with period 30. SMA 30 is said to be “slower” because it takes into account older price movements compared to SMA 9, which is more sensitive to recent price movements.
Judging by the MAs on the chart, we can see that the EURUSD pair is moving in an uptrend, as the price is generally above the SMA 9 line, which in turn is above the SMA 30 line. This is characteristic of a healthy uptrend in any market.
Bollinger Bands on MT4
Bollinger Bands (BB) is another widely used indicator. In fact, Bollinger Bands are also based on Moving Averages, but it adds its own twist to it. The Bollinger Band indicator consists of a center line, which is generally a 20-period SMA, and two outer bands, which are generally two standard deviations above and below the center line. Thus, the upper and lower bands together form a channel, with the price trading inside it most of the time.
Here is what the BB indicator looks like on the MT4 chart:
The Bollinger Bands not only help us understand the trend but also determines the volatility of the price and anticipate potential support and resistance levels. Some traders use Bollinger Bands to open a position when the price touches one of the bands. For example, in an uptrend, we can open a long position when the price touches the lower band. This is commonly recognized as an indication that the short-term correction may soon end, and that the price will resume its previous uptrend again.
A simple trading strategy: moving averages
Now that we know some basic trend indicators, let’s put them into practice. The most well-known strategies are the moving average crossovers.
Here’s a strategy that is generally considered by traders as an effective forecasting method. For this, you have to apply two exponential moving averages (EMAs) to your chart – the first one should be set to 9 periods (Fast EMA), and the second should be 14-periods (Slow EMA).
The trading conditions are simple:
- When trading EMAs, a trader usually opens a long position when the Fast EMA crosses the Slow EMA from bottom to top. The stop-loss can be set at the lowest point of the bar before the crossover.
- On the other hand, the strategy would then indicate a sell position (open a short position) when the Fast EMA crosses the Slow EMA from top to bottom. The stop-loss can be set at the highest point of the bar before the crossover.
- Take-profit is tricky, but 2 times the distance from the entry to the stop-loss level might be a place to start looking. Here is what it looks like on the chart:
It’s important to mention that it’s better to pause trading if the two EMAs are moving horizontally for a longer period, which is a typical sign of a market that is not trending in any direction, but rather stuck in a range. Also, you might want to close the position if the EMAs are crossing again before touching the stop-loss or your take-profit level.
There are many trading strategies that incorporate moving average lines in one way or another. Traders all around the world are known to use this very simple trend-following trading strategy, which are based almost entirely on moving average cross-overs. Whether you also want to try the same trading strategies in your own trading is up to you, but always keep in mind that new strategies should be tested before you implement them live. The Exness demo account is free and gives secure and easy access to the markets and technical indicators. Simply open an account with Exness, then select the demo option and practice your trading strategies risk-free. You’ll know when you are ready to start trading in the real markets.
try trading the trend