What is trend trading in forex?
Trend trading is one of the most popular trading methods in the forex market for assorted reasons. In this article, we’ll explain the attraction as we take a deep dive into the subject of trend trading.
We’ll discuss the simplest methods to find trends, such as using trend lines and candlestick price action and show you how to compile robust trend trading strategies.
What is trend trading
We instinctively know what a trend is because we come across trends in many aspects of our lives, such as fashion, music, or a trending subject on Twitter.
We’d describe a trend as a popular new movement, direction or chatter that continues for a while before the subject loses the public’s interest and begins to tail off.
Such a description also fits with our views of financial markets. Price will trend for a time in either a bullish or bearish trend (or sideways) before market interest and sentiment changes.
Trend trading currency pairs involve finding a pattern that suggests enough interest in terms of trading volume and volatility is present in the market to support the current direction of travel.
When you trend trade, you have a straightforward mission; you try to enter the market when you think the trend has begun and exit when it’s nearing its end. You can use the various technological tools available to identify the trend’s direction, and we’ll highlight some of the technical trend indicators later.
How to trade with the trend in forex
“The trend is your friend until it bends at the end” is a time-honoured phrase in the forex trading community. Certainly, trend trading makes your job (of taking money out of the market) potentially easier. You’re not looking to be a contrarian; you ride the trend until you believe it’s exhausted.
Trend trading is one of the most reliable, predictable and safest methods to trade FX markets. Many traders will contend that you take far less risk when you take trades in the trend direction. Your skill involves timing your entries and exits to make sure you’ve captured enough of the move and profit.
How to find a trend
Trendlines and candlestick price action patterns are the two most straightforward methods many forex traders use to identify trends.
With a bullish trendline, you look at your time frame and see if you can draw a line under the recent movement, which indicates that the currency pair’s price continues to move higher. The opposite analysis is valid for a bearish trend.
Very few movements in our FX markets are smooth straight lines for extended periods. Therefore, you draw the trendline for a bullish move where price pulls back and retraces to test the direction.
If the price falls back, tries to pierce the line but then continues its bullish trend, it suggests the sentiment is still strong. Similarly, if price continues to reach new highs it also indicates the bullish momentum is strong.
Drawing trendlines on your charts couldn’t be easier. Draw lines to match up the highs or lows if you’re looking to go long or short. You can draw a trendline above and below price to see if a channel can be drawn. If the channel expands the current momentum is continuing. If the channel gets narrow the move could be ending.
The concept of higher highs and lower lows is one of the fundamental aspects of forex price action trading. You analyse your charts to establish if the price makes higher highs for bullish moves or lower lows for bearish moves. If it is, on whichever time frame (or combination of timeframes) you use to make your judgment, then the momentum and trend are probably continuing.
Changes in the trend typically occur when fresh highs and lows stop getting printed. If you see lower highs or higher lows in your candlestick patterns, then the pair’s price could be consolidating and getting ready to turn.
Trend trading technical indicators
So, let’s look at a few of the most popular trend technical indicators, some simple, others slightly more complex. First, let’s consider the most straightforward trend indicator, a moving average.
As the name suggests, the indicator smooths the past price data by creating a single line. It moves as the average price changes. The simplest method to ensure you are on the right side of the trend involves trading above or below the moving average (MA).
For instance, if the price remains above the moving average for an extended period, the market is considered bullish and in an uptrend. If the moving average is above the price, the market is bearish and in a downtrend.
This observation is one of the simplest methods to ensure you trade with the trend. Your trading decisions will alter if you’re a day, swing or position trader, but the principle remains the same; MA below price equals bullish conditions, above equals bearish on whatever timeframe you prefer.
Taking this analysis further, many traders will only go long if the MA is below the price of an FX pair and only go short if the MA is above the price.
One common trading strategy is to combine two moving averages to gauge if there’s been a sudden shift in sentiment. Traders will choose a fast-moving and slow-moving MA, and when they cross, they’ll make a trading decision.
For example, they might choose a 5-day MA and 21 MA placed on a 4hr or daily timeframe, and when they cross, traders conclude that the current trend has reached its end.
They might select what’s called an EMA, an exponential moving average, in preference to the standard smoothed MAs because the EMAs deliver more dynamic information.
You enter long positions when the fast EMA crosses the slow EMA from below and go short when the fast EMA crosses the slow EMA from above.
- Relative strength index (RSI)
The relative strength index (RSI) shows price momentum and signals overbought or oversold conditions. It measures the average gains and losses over a certain number of periods by calculating if more of the price movements were either positive or negative.
The RSI fluctuates on a scale between 0 and 100. When the indicator moves above 70, the market is considered overbought. A reading below 30 is a sign of an oversold market. Traders use these levels as signals the trend might be reaching its end.
Trend traders in long positions use the overbought signal to lock in their profit and exit their trade. At the same time, a trader looking to go short could use the overbought signal as an entry point.
For the reverse situation, trend traders use the oversold signal as the point at which to exit short trades and go long.
The Moving Average Convergence Divergence (MACD)
The MACD is a trend-following indicator that shows momentum by illustrating the relationship between two moving averages. It’s a popular and highly functional technical indicator favoured by both novice and experienced traders.
The MACD gets calculated by subtracting the 26-period exponential moving average (EMA) from the 12-period EMA. The resulting calculation is the MACD line.
There is a histogram typically displayed with the two lines. As a visual prompt, traders can use the histogram to see the bearish and bullish conditions.
MACD triggers technical signals when it crosses above or below its signal line. Above the signal line, it’s a buy signal; below is a sell signal.
The speed of any crossover can be a signal of a market that’s overbought or oversold. MACD can reveal if the bullish or bearish movement is strengthening or weakening.
Trend trading forex strategies
We’ve already covered how to use trendlines, basic price action candlestick formations, moving averages and two specific technical indicators; the RSI and MACD.
Because they all differ and generate different information and signals, we can combine some of these to create an easy-to-follow trading strategy. So, we’ll choose trendlines, price action and the RSI and MACD and build our system.
Let’s suggest we’re looking at our 4hr time frame as a swing trader to see if we can establish a bullish trend.
Trendlines
Can we identify new highs getting reached during recent sessions and the current session, and when pullbacks and retracements occur, does the price appear to reject these levels and continue to push higher?
Price action
Is the price action bullish? Are recent candles bullish? Are the bodies whole and the wicks/tails of the candle on the top? Can you see the development of standard bullish candlestick patterns, such as three soldiers?
RSI
Has the RSI moved out of the oversold area but still some distance short of the overbought zone? Some traders use the median level and line of 50 before entering long (or short) trades. Once it crosses, they might use it as a signal to enter, believing that the currency pair still has some momentum to travel before it emits oversold or overbought readings.
MACD
Have the signal and MACD lines crossed? Has the histogram changed colour from its standard red bars to green? How aggressive the change has been will illustrate how much volatility is driving any shift in sentiment.
These four simple observations and interpretations can form the basis of the most straightforward trend trading strategy. And if applied as part of a swing or position trading style, traders will have enough time to ensure all their conditions get met before committing to the transaction.
Click on the button below to Download our "What is trend trading in forex?" Guide in PDF
