How Trend Following Strategy Can Be So Popular?
Trend following is perhaps the most popular long-term strategy in all financial markets. As a trading strategy it is exceedingly effective and profitable when the conditions are favorable, is quite straightforward in its methodology, and there are many individuals, past and present, famous or obscure, who have used this strategy to success and rich.
Sometimes a market breaks out of a range, moving below support or above resistance to start a trend. Trend following is not a short-term method, and patience and determination are as important as correct analysis as a result.
To apply this strategy we must first be aware of the existence of a trend. Without identifying a trend we would be gambling, and that’s not the purpose of trading forex. Both fundamental and technical analysis can be employed for identifying a trend, and both of them have their advantages and drawbacks. It is in general a good idea to use a combination of them for deciding on the trend’s character, and deciding on our entry and exit points.
When support breaks down and a market moves to new lows, buyers begin to hold off. This is because buyers are constantly seeing cheaper prices being established and want to wait for a bottom to be reached.
At the same time, there will be traders who are selling in panic or simply being forced out of their positions. The trend continues until the selling is depleted and belief starts to return to buyers that the prices will not decline further. Trend-following strategies buy markets once they have broken through resistance and sell markets once they have fallen through support levels.
Trends can be dramatic and prolonged. Because of the magnitude of moves involved, this type of system has the potential to be the most successful Forex trading strategy.
Here's the good news:
...if the indicator can distinguish a time when there's an improved chance that a trend has begun…
...then you are tilting the odds in your favour.
The indication that a trend might be forming is a breakout.
Trend-following systems use indicators to tell when a new trend may have begun but there's no surefire way to know of course. A breakout is when the price moves beyond the highest high or lowest low for a specified number of days.
For example, a 20-day breakout to the upside is when the price goes above the highest high of the last 20 days.
Trend-following systems require a particular mindset.
Because of the long duration – during which time profits can disappear as the market swings – these trades can be more psychologically demanding.
When markets are volatile, trends will tend to be more disguised and price swings will be greater. This means a trend-following system is the best trading strategy for Forex markets that are quiet and trending.
An example of a simple trend-following strategy is a Donchian Trend system.
Donchian channels were invented by futures trader Richard Donchian and are indicators of trends being established. The Donchian channel parameters can be tweaked as you see fit, but for this example we will look at a 20-day breakout.
A Donchian channel breakout suggests:
...buying if the price of a market goes above the highest high of the prior 20 days or…
...selling if the price goes below the low of the prior 20 days.
There's more.
The trend that we seek to trade is different from random fluctuations, range patterns and similar price movements in that the price itself, in the absence of any technical indicator, can still be recognized as showing a trend. In other words, there is some driving conviction behind the price action which allows the trader to easily identify it visually. Depending on the type of the trend (that is, an up- or downtrend), successive highs and lows should constitute a rising or falling pattern, with relatively few irregularities. But such a case is often a rarity, and the trader will have to back his technical patterns with conviction that can perhaps only be gained through fundamental analysis.
In order to only trade when the market state is more favourable to the system, there is an additional rule. This rule is designed to filter out breakouts that go against the long-term trend.
For this rule you look at the 25-day moving average and the 300-day moving average. The direction of the shorter moving average determines the direction that is permitted.
This rule states that you can only go:
short if the 25-day moving average is lower than the 300-day moving average.
long if the 25-day moving average is higher than the 300-day moving average.
Trades are exited in a similar way to entry, but using a 10-day breakout.
That means that if you opened a long position and the market goes below the lowest low of the prior 10 days, you would sell to exit the trade and vice versa.
Sometimes a market breaks out of a range, moving below support or above resistance to start a trend. Trend following is not a short-term method, and patience and determination are as important as correct analysis as a result.
To apply this strategy we must first be aware of the existence of a trend. Without identifying a trend we would be gambling, and that’s not the purpose of trading forex. Both fundamental and technical analysis can be employed for identifying a trend, and both of them have their advantages and drawbacks. It is in general a good idea to use a combination of them for deciding on the trend’s character, and deciding on our entry and exit points.
When support breaks down and a market moves to new lows, buyers begin to hold off. This is because buyers are constantly seeing cheaper prices being established and want to wait for a bottom to be reached.
At the same time, there will be traders who are selling in panic or simply being forced out of their positions. The trend continues until the selling is depleted and belief starts to return to buyers that the prices will not decline further. Trend-following strategies buy markets once they have broken through resistance and sell markets once they have fallen through support levels.
Trends can be dramatic and prolonged. Because of the magnitude of moves involved, this type of system has the potential to be the most successful Forex trading strategy.
Here's the good news:
...if the indicator can distinguish a time when there's an improved chance that a trend has begun…
...then you are tilting the odds in your favour.
The indication that a trend might be forming is a breakout.
Trend-following systems use indicators to tell when a new trend may have begun but there's no surefire way to know of course. A breakout is when the price moves beyond the highest high or lowest low for a specified number of days.
For example, a 20-day breakout to the upside is when the price goes above the highest high of the last 20 days.
Trend-following systems require a particular mindset.
Because of the long duration – during which time profits can disappear as the market swings – these trades can be more psychologically demanding.
When markets are volatile, trends will tend to be more disguised and price swings will be greater. This means a trend-following system is the best trading strategy for Forex markets that are quiet and trending.
An example of a simple trend-following strategy is a Donchian Trend system.
Donchian channels were invented by futures trader Richard Donchian and are indicators of trends being established. The Donchian channel parameters can be tweaked as you see fit, but for this example we will look at a 20-day breakout.
A Donchian channel breakout suggests:
...buying if the price of a market goes above the highest high of the prior 20 days or…
...selling if the price goes below the low of the prior 20 days.
There's more.
The trend that we seek to trade is different from random fluctuations, range patterns and similar price movements in that the price itself, in the absence of any technical indicator, can still be recognized as showing a trend. In other words, there is some driving conviction behind the price action which allows the trader to easily identify it visually. Depending on the type of the trend (that is, an up- or downtrend), successive highs and lows should constitute a rising or falling pattern, with relatively few irregularities. But such a case is often a rarity, and the trader will have to back his technical patterns with conviction that can perhaps only be gained through fundamental analysis.
In order to only trade when the market state is more favourable to the system, there is an additional rule. This rule is designed to filter out breakouts that go against the long-term trend.
For this rule you look at the 25-day moving average and the 300-day moving average. The direction of the shorter moving average determines the direction that is permitted.
This rule states that you can only go:
short if the 25-day moving average is lower than the 300-day moving average.
long if the 25-day moving average is higher than the 300-day moving average.
Trades are exited in a similar way to entry, but using a 10-day breakout.
That means that if you opened a long position and the market goes below the lowest low of the prior 10 days, you would sell to exit the trade and vice versa.
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