A trend trading strategy simply refers to a trading strategy that aims to profit from a prolonged pattern of rising or falling prices in the market. In other words, a trend trading strategy aims to profit from a rising or falling trend in the market.
Trends follow periods of consolidation and are usually triggered by market fundamentals. There are usually news items that are able to radically alter the trading bias of traders in the market. These news items can cause traders to either buy or sell a currency en masse. Usually traders sit on the sidelines when expecting these news items and this produces the range-bound periods of the market. This is like the calm before a storm. Periods when the market is range-bound are commonly found in the forex market. These periods are as follows. Eventually the news is released and traders enter the market. There is a surge in trading volumes and increase in volatility. If more traders are buying than selling, the trend will be upwards. If more traders are selling than buying, the trend is downwards.
There is an important point to note when trading the trend, and that is the place of retracements in price action. Trends do not always move in a straight line. There will be periods of ebbs and flows just like the current of a river. These are occasions when trading volumes drop but mostly due to profit taking from traders who got in early on the trend. To take profit, a trader has to assume a reverse position to the initially traded position. So a trader who bought a currency at a value has to sell at a higher value to make profit. This selling action after a previous buy will cause prices to retrace downwards in an upward trend. The reverse will also be the case in a downward trend. Retracements present a sound opportunity for those who missed the initial trade to re-enter the trend, and also allows early birds a second opportunity at profit.
So trading a trend will involve:
- Being able to catch it early when the previous trend has reversed.
- Being able to enter at a retracement point.
Early Entrance into a Trend
To enter a trend early, the trader must be able to catch the reversal of a previous trend. This is achieved by the use of:
- Candlestick reversal patterns with strong degree of market impact e.g. an evening or morning star doji.
- Reversal chart patterns e.g. cup and handle pattern.
Usually these patterns form in the context of major fundamental news impact which causes a complete reversal of trader sentiment. For instance, if the US Fed Reserve were to hypothetically make a decision to cut interest rates to zero from its present levels, it would cause a surge in the value of emerging market currencies and cause them to reverse from their 2015 downtrend. So the power of fundamentals must never be excluded when considering trend reversals.
Retracement entry depends on the trader waiting for prices to pull back a little to defined spots, and then entering the trade in the direction of the previous trend so as to catch the rest of the move until fundamental factors cause a long-term reversal of the trend. This can be achieved with the following tools:
- The Fibonacci retracement tool
- The ascending and descending channels
- Trend lines
- Gann Fans
- Fibonacci arcs