5 Trading Strategies to Follow the Trend
Trend trading is the ultimate reason why retail traders join online trading. Technical analysis is full of trading strategies to follow the trend, but there are other points where the retail traders struggle.
With this article, I aim at revealing five (but you can derive from these ideas more) strategies to follow when trend trading. The ideas behind are sublime and simple, just like trading is supposed to be for the traders looking for those approaches.
Why is that?
One thing that we should make clear from the start is: trend trading is a conservative approach to speculation.
Trading strategies to follow the trend, for this reason, are simple, less risky and appeal to all types of traders, especially those in need of confirmation before diving into the market.
Conservative traders look for signs that a trend is in place before dedicating some money to a position.
Aggressive traders, on the other hand, always love to play with the possibility of picking a market top or bottom.
Therefore, the strategies to follow the trend presented in this article appeal more to conservative traders.
However, the ideas to be introduced are valid for traders with all personalities and strategies, as they can usually complement other strategies.
As always, I will try to give as many examples to illustrate the trend trading strategies as possible. I’ll cover, among others:
Contents in this article
- Strategy Nr. 1 – Adjusting the Main Trendline For Perfect Trend Riding
- Strategy Nr. 2 – Trading Strategies to Follow the Trend Using a Channel
- Strategy Nr. 3 – Trend Following with Moving Averages
- Strategy Nr. 4 – Using Oscillators in Trading Strategies to Follow the Trend
- Strategy Nr. 5 – Trend Trading with MACD
The Trend is Your Friend
That’s very much true, but are you able to identify trending conditions? Because one thing you should know from the start: statistics don’t favour trending conditions in the FX market.
In fact, the reality says the opposite. The market spends a lot of time in consolidation (as much as 65% or more), depending on the currency pair traded (e.g., cross pairs – the ones that don’t correlate to USD – spend more time in ranges than majors – the ones that do relate to USD).
Nevertheless, trends do exist.
As a rule of thumb, the bigger the timeframe, the stronger the trend.
For this reason, trend trading is much more powerful and yields better returns if it takes place on bigger time frames. Think of daily and above, and you have the right picture.
A trend trader faces many pitfalls. Riding a trend is one thing, but the real challenge is to watch out for reversal conditions continually.
A trend is your friend until the trend reverses. And, a reversal doesn’t necessarily mean the start of a new trend, in the opposite direction.
It may, or it may just be the start of a prolonged consolidation period.
Coming back to the point this article is trying to make, here are the five trading strategies to follow the trend that should suit any currency trader.
Strategy Nr. 1 – Adjusting the Main Trendline For Perfect Trend Riding
This is, by far, the biggest challenge in the life of a trend trader. It is particularly tricky in the currency market to follow a trend due to the increased volatility generated by automatic trading.
It gives the market a chaotic behaviour, difficult to interpret during a trend’s formation.
Before anything, a trend is a combination of a multitude of lower lows (LL) and lower highs (LH) (bearish trend) or multiple higher highs (HH) and higher lows (HL) (bullish trend). Check them out below:
- Bearish Trend
Trends are visible only after drawing a line: the trendline, hence the name.
The proper trendline isn’t constant. It changes and adapts with the new market conditions as the trend develops. Therefore, the key to follow the trend is to make sure you know how to draw the trendline as the trend unfolds.
Below is the weekly AUDUSD chart. It shows a strong bearish trend, for the entire of 2018. But don’t get too excited: at the start of it, no one knew how the trend will unfold.
Therefore, it is mandatory to take things step by step in when building strategies to follow the trend.
Have a closer look at the chart above and imagine you know only the first part of it. The rest is unknown, and the strategy to follow the trend builds based on how the trend evolves in 3 stages.
- First Stage– The first thing to do is the connect the absolute high with a lower high. That’s the main trendline at this point, and the previous support gave way, confirming the start of a potential trend.
Naturally, support turns into resistance and traders drag the trendline to the right side of the chart. The idea is for the price action to not close above the main trendline as it is at this point.
- Second Stage– If it pierces it, as it does below, but not closes above, it is just the right place to sell or go short and then adjust the main trendline to the new spike.
Basically, selling takes place in both dynamic (from falling trendline) and classic resistance, difficult to overcome especially considering the timeframe (weekly).
- Third Stage– The next thing in line is to repeat the process for as long as the price fails to close above the adjusted trendline.
Note: the trendline adjusts to the previous swing high only after the market makes a new lower low, thus confirming the trending conditions.
In the end, the market has the power to close above the adjusted main trendline, and that marks the end of the trend.
Remember: As mentioned earlier, it is not mandatory for the price to start a new trend after the trendline is broken. It may just be that a consolidation period begins before the old trend continues.
Strategy Nr. 2 – Trading Strategies to Follow the Trend Using a Channel
Channels are great for visualizing the trend. But traders fail to understand that the perfect channel or the perfect trend rarely exists on the currency or any other market.
Instead, the market is chaotic enough to break dynamic support and resistance, but that won’t change the channeling component of a trend.
The AUDNZD chart from above shows how a channel should be treated when riding a trend. To start with, the first indication of a bearish trend is when the market breaks the previous higher low.
In the chart, it is marked with the grey area. Eventually, the price pierces below, opening the gates for possible strategies to follow the trend.
Channeling is just one of the many…
While this holds true as a dominant strategy, the best way to benefit from a trend while using a channel is to look for more. Namely, look for breakouts.
The idea of this strategy is not new. John Bollinger built the Bollinger Bands indicator starting with one thing in mind: the price stays most of the time inside the two bands, but not ALL of the time.
Statistically, it stays above 95% of the time inside the Bollinger Bands. And, the rest outside of it. It makes a compelling case to try to do something when the price deviates from it.
According to Bollinger, it is only normal for the price to deviate during a trend’s evolution. Hence, look for the price to break out a bit from the channel and use that as an opportunity to go long or short.
In fact, I would be worried to trade the edges of a perfect channel, for the simple reason that trending conditions do not favour the perfect channel formation.
Another relevant topic here would be the bear/bull trap. You can check it out HERE.
Strategy Nr. 3 – Trend Following with Moving Averages
We cannot talk about trend trading without mentioning Moving Averages. Fantastic technical analysis tools, they have the quality of always showing the true market stance.
You cannot argue with a bearish or bullish market as long as the price remains below or above a major moving average.
Two moving averages stand out of the crowd in the technical analysis field:
- the MA(200)
Not that traders cannot set the period above the two hundred level, but the more periods, the flatter the average becomes and in the end it will tend to become horizontal. Therefore, it loses its value.
For this reason, the MA(200) is “sacred” in the world of technical analysis and, when price approaches it, all trend traders pay attention to it. Needless to say, the bigger the timeframe, the stronger the role of the MA(200) as a support/resistance.
The second moving average (MA50) became famous because of the MA(200). The combination of the two can give you one of the greatest signals of market changing conditions from bullish to bearish or from bearish to bullish.
Called golden crosses or death crosses, they ignite traders to react quickly as market conditions change.
Trading Setup to Follow the Trend
The idea is to bring the two averages together on the same chart. The higher the timeframe, the stronger the implications.
Here’s the GBPUSD on the weekly. It shows price action for the past four years and makes the Brexit event in the summer of 2016 look almost insignificant in the overall trend interpretation.
Well, the market was already bearish. The blue circle shows the death cross the formed well ahead of the referendum, as the MA(50) crossed below the MA(200).
Remember the main quality the moving averages possess?
Visibility of the major trend, helping traders define if the trend is bullish or bearish. It was already a bearish market when the people in the United Kingdom voted in the Brexit referendum, but that’s not the point of this strategy.
The point is to use the averages to trade when the market tests them.
Savvy traders use the first two tests as entries in a trade while avoiding any other subsequent attempt. The price’s ability to keep coming to the moving average is a sign of trend’s exhaustion, not a display of strength.
Following these rules, the MA(50) already provided two opportunities to go short, so any other trade is forbidden. As for the MA(200), the price was already rejected once, with one more opportunity in cards.
Strategy Nr. 4 – Using Oscillators in Trading Strategies to Follow the Trend
Remember what we said earlier? Trend traders are conservative.
But even among conservative traders (i.e., risk-averse), there are some that go an extra mile to protect the trading account. There is nothing wrong with it!
Introducing oscillators to the grand scheme. Any oscillator will do the work here, but some professional traders are using one less famous to retail traders: DeMarker.
Developed by Tom DeMark, it is publicly available to any MT4 or MT5 user.
It is somehow similar to the RSI in the sense that it shows overbought and oversold conditions, but there is one major difference: it reaches those levels faster.
Therefore, traders get the chance to spot possible reversals quicker than using the RSI.
Applied on the same GBPUSD weekly chart from above, the oscillator reinforces the entries mentioned earlier. It is not by chance that the entries happen to be in the overbought area.
Now that we know the entry, what about the exit?
One way to measure it is to set the stop at the MA(200) and target the oversold with the DeMarker. Both MA(50) trades proved to offer impressive risk-reward ratios using this setup.
As for the MA(200) trade, the proper way to set up the stop is to use the distance between the two averages as the distance to place the stop while keeping the exit strategy the same.
Strategy Nr. 5 – Trend Trading with MACD
The MACD (Moving Average Convergence Divergence) is a mix between a trend indicator and an oscillator. For this reason, it earned its place in an article revealing trading strategies to follow the trend.
This one is quite simple and works with many other oscillators that have both positive and negative values. It is based on crossing the zero level.
When doing that, the price action shows continuity, switching from negative to positive or from positive to negative. Or, in the trading world, continuity shows nothing but trending conditions, the main reason why you’re reading this article.
The crossing of the zero level can be deceiving, though. As it happens, the market consolidates a lot even on the larger timeframes.
Therefore, the way to spot a trend is to use a trendline and connect the low (in a bullish trend) with the candlestick corresponding to the crossing and project the trendline on the right side of the chart to highlight the trend.
This article helped clarify that the way to approach a trend differs depending on a trader’s personality and his/her trading style. I didn’t even touch on trend reversals, even though reversals are the “genesis” of trend trading.
They offer the advantage of entering early in a potential new trade, but the drawdown is that you are in a trend prematurely. However, with proper money management and sound risk-reward principles, anything is possible.
In trend trading as well as in trend reversing, the traders’ personality plays an important role. People react differently to different market conditions and to the idea of making or losing money.
The biggest drawdown to trend trading analysis is that all the work and strategies are done after the the pattern has occurred. That is why I prefer using price action as my main trading strategy.
After all, the financial markets do trend. Depending on the time horizon of a trade, trends are of a larger or smaller scale.
Using them on the lower timeframes comes at the expense of being stopped for the simple reason that the smaller the timeframe, the larger the noise is. Therefore, I do not recommend using them on any timeframe that is below 1 hour.
In the end, it is up to the trader. In any case, the five trading strategies to follow the trend presented here should be part of the technical analysis arsenal of every trader that respects his/her work.