The Forex market appears to be custom built for the trend following strategy. Long term directional movements are obvious in the major currency pairs and Trend Following captures these moves.
This article will describe the Trend Following strategy, show how it can be applied to the Forex market, talk about the pitfalls and benefits of the strategy, and show an example of what successful Forex trend following looks like.
Traditional Trend Following teaches buying new highs and selling new lows is how to enter the market. Other schools of thought try to fine tune the traditional method by buying pullbacks on shorter time frames within the overall longer term uptrend.
Trend Followers usually believe that price is the only thing that matters when making trading decisions. They tend to discount fundamental data, believing that all information is inherent in price itself.
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In fact, some famous Trend Followers even go as far to say that price makes news, not that news makes price. Remember, simply reverse these rules if you wish to enter short within a down trend. Here are the steps to follow to trade with the traditional Trend Following method:
- Ascertain trend— which way is the pair moving? Take a look at a several year chart, is it trending up or down? Let’s assume your chosen pair is trending up.
- Pick your entry point— the best way to enter a trend trade is hotly debated. As stated earlier, traditional trend traders will buy whenever a new high is reached. Others will wait for a pull back to the Moving average, or a pull back within a shorter time frame chart.
- Patiently wait– for the trend to continue carrying your position into profits. This is the hardest part for most traders. Trend Following is a slow, grinding trading process.
- Exit the trade—-Wait until the trend appears to have changed totally prior to exiting. This is another nebulous trend following rule. The question if this is just a drawdown or an actual change in trend is a difficult one to answer in real time. However, it looks like an easy one in hindsight. One needs to follow strict rules concerning exits when Trend Following. Discipline is critical for this strategy.
What I like is a combination of Trend Following and fundamental/news research as a trading strategy. I don’t believe that pure price is enough to make proper trading decisions in the Forex market. With this said, Trend Following has its place as part of a complete strategy, not the total strategy.
Trend Trading obviously works in the Forex market, however it’s harder than it looks. Large draw downs are an inherent part of the strategy. The Forex market has severe intraday swings that will knock out all but the very convicted, disciplined trend trader. Determining what drawdowns are actual changes in trend can’t be known until after the fact. Therefore, a strict set of rules and strong discipline are a must to make money Trend Following.
David Goodboy is Vice President of Business Development for a New York City based multi-strategy fund.