Those who don’t know what trading actually means often think that it is nothing but gambling. You will make a profit if luck is in your favor, else you will go bankrupt. This is a misconception and highly misleading. Trading is all about building winning strategies and making calculated moves to make a profit. Traders and investors keep an eye on the market and analyze it before making any investment. One of the most common strategies followed in the trading world is following a trend. It is often deemed as the best forex trading strategy as well.
Let’s find out what these trends are and how they can be used.
The Best Forex Trading Strategy
In the long run, the best forex trading strategy (several weeks holding period) is a trend-following trading strategy based on various scientific research papers and statistical tests conducted by prop companies. Currency and commodity markets showed excellent performance using trend-following strategies when the holding period was at least one month.
Usually, statistical evidence shows that if price is above SMA 200 on the daily chart and interest rate and GDP for both currencies confirm bullish trade, we can expect a further bullish trend. With the same analogy, if the price is below SMA 200 on the daily chart and interest rate and GDP for both currencies confirm bearish trade, we can expect a further downtrend.
Let us give you some examples.
One of the systems that we tested on the forex and commodity market in our prop company was an excellent research paper, Trend-following trading strategies in commodity futures: A re-examination. Using the research paper, we repeated the experiment and watch the performance of trend-following trading strategies in commodity futures markets using a monthly dataset spanning 55 years and 28 markets and forex market on 10 major forex pairs in the last 50 years. We tried to repeat experiments with fresh data watching profitability associated with dual moving average crossover (DMAC) and channel strategies. This study and our study showed that pure trend-following strategies generally produce higher mean returns and Sharpe ratios than momentum strategies.
The empirical studies on currency investing have frequently created portfolios by sorting currencies into baskets using some methodology (research paper link about methodology), like momentum, and then equally weighting the currencies in each basket. This approach can be used, but currency pairs shouldn’t always be treated equally in the portfolio.
If you are a trader and use a trend-following strategy, you can get the best performance if your time frame is longer than shorter (day trading has lower performance). When you change target and stop loss in your trade, the rebalancing period should be between 1 week to at most 1 month (in our research). No model of risk adjustment can plausibly explain the robust findings of the profitability of technical analysis in the foreign exchange market (Can risk explaining the profitability of technical trading in currency markets). Because of that, stop loss and target calculation, risk management – is no simple thing. Traders need to do rebalancing of trades after some period based on volatility, trading news, etc.
Our team in the Leanta trading Group develop various trend-following systems using evolutionary computation and genetic programming, and machine learning approach in a wide time span. Our research’s Best Forex Trading Strategies are always related to previous highs and lows and longer time frames (open trade duration). So we believe that the best strategies are always connected with well-defined price levels and macroeconomic parameters.
Now, some basic stuff about the trend for beginner traders.
Defining a Trend
There are different types of trends that traders use to make gains. Trend trading involves analyzing the momentum of an asset in a singular direction and making an investment by making speculations using that momentum.
Trends can be channels with lower and upper trendlines that run parallel to each other. Some trends even have a single line. Both reflect different momentums. These trendlines will seldom remain perfectly symmetrical. Traders remain flexible and form strategies according to how the market is acting.
If you are a new trader, you might find trend trading a little confusing. Many new traders make the mistake of following trends blindly. They believe that they can get in using the existing price action and make a profit. This is not possible in the majority of cases. If you start your trend trading journey, you will often question if the lines show you a new trend or just a retrace? Some traders are not sure if it is the right time to get on a new trend, while others wonder if they should be taking the risk or not.
These questions arise because novice traders are not experienced enough to see the bigger picture. Read along, and you will get most of your questions answered.
How to Know If It’s a Trend or a Retrace
Of the most common problems that new traders have with the trend, trading differentiates between a trend and a retrace. To avoid any confusion, all you need to do is to wait. Allow the trend to form properly and reach specific levels. If you rush, you might start trading alongside a retrace which can cause losses when the prices start reversing.
If you are still unsure about it, it is better to leave that trend and wait for a new one. You can even take the help of an expert. They can guide you on how to identify trends.
Very often, it is hard to distinguish whether the position is a trend or retrace. Even experts can have different opinions about that.
When is the Right Time to Get in on a Trend?
Once you have enough knowledge to differentiate between a trend and a retrace, the next question is whether you are on time to ride the trend or not. Sometimes it takes longer to identify a trend that leaves traders confused about whether they are late to trade alongside it or not. Traders want to catch trends as early as possible to make maximum profit. This takes time and practice as possible only when you can identify a trend even before it becomes defined.
Usually, the best time to enter into trend-following trade is when the price level breaks some important price level such as weekly high or low, or monthly high or low, important Fib. Level etc.
Is the Risk Worth it in trading?
Risk is worth it if our analysis shows that the risk-reward ratio is equal or below 0 (for example, 1:2 ) and if the past performance follows our strategy. Trading is never without risk lurking around, but that does not mean that you will go in without making a strategic plan. To check whether you should ride a trend, check the potential of the direction that you would want to enter.
Selecting the Right Trend Trading Strategy using Simple rules
Just identifying a trend is not enough. You must learn how to process it and use it to your advantage. Here are three trend trading strategies that you can employ to make profits:
- The first approach of entering and letting the trade run is appropriate for traders who do not wish to take many risks. It is straightforward; all you need to do is identify the trend and run until it starts retracing. This trade is best suited for new traders as well. When the support line breaks on the daily chart, it confirms a trend. You can enter the trade at this time and leave when the trend is no longer in your favor.
- Moderate-risk traders can use the second strategy. If you are looking to make slightly higher profits by risking a little more, you can try the ‘in and out technique. It would help if you placed the trade concerning the main trend, but the time frame chart analysis will be smaller. These traders take a position when the trend has started retracing. The time frame chart remains smaller.
- The third strategy is for veteran traders who are ready to risk more and gain more. This strategy is called ‘adding up.’ It is a mix of the other two strategies. Here, you enter a long trade after identifying the trend and subsequently add to the same position as it retraces but for a shorter timeframe chart. You can use this strategy to make big [profits, but this is not for novice traders. It would help if you were highly cautious while using this strategy.
Irrespective of the instrument you are trading, it is important to identify trends to make profits. Trend trading is very profitable. Whether you are new to trading or not, there is a trend trading strategy for everyone. If you still don’t feel confident enough, you can always take the help of a broker or experienced trader.