In theory, trend trading is easy. All you need to do is keep on buying when you see the price rising higher and keep on selling when you see it breaking lower. In practice, however, it is far more difficult to do this successfully. The greatest fear for trend traders is getting into a trend too late, that is, at the point ofexhaustion. Yet despite these difficulties, trend trading is probably one of the most popular styles of trading because when a trend develops, whether on a short-term or long-term basis, it can last for hours, days and even months.
Tutorial: Forex Trading Rules
- 50 simple moving average (SMA) - the signal line that triggers the trades
- 100 SMA - gives a clear trend signal
The actual time period of the SMA depends on the chart that you use, but this strategy works best on hourly and daily charts. The main premise of the strategy is to buy or sell only when the price crosses the moving averages in the direction of the trend. (To learn more, read the Moving Averages tutorial.)
- Wait for the currency to trade above both the 50 SMA and 100 SMA.
- Once the price has broken above the closest SMA by 10 pips or more, enter long if MACD has crossed to positive within the last five bars, otherwise wait for the next MACD signal.
- Set the initial stop at a five-bar low from the entry.
- Exit half of the position at two times risk; move the stop to breakeven.
- Exit the second half when the price breaks below the 50 SMA by 10 pips.
- Once the price has broken below the closest SMA by 10 pips or more, enter short if MACD has crossed to negative within the last five bars; otherwise, wait for the next MACD signal.
- Set the initial stop at a five-bar high from entry.
- Exit half of the position at two times risk; move the stop to breakeven.
- Exit the remaining position when the price breaks back above the 50 SMA by 10 pips. Do not take the trade if the price is simply trading between the 50 SMA and 100 SMA.
Long TradesOur first example in Figure 1 is for the EUR/USD on an hourly chart. The trade sets up on March 13, 2006, when the price crosses above both the 50-hour SMA and 100-hour SMA. However, we do not enter immediately because MACD crossed to the upside more than five bars ago, and we prefer to wait for the second MACD upside cross to get in. The reason we adhere to this rule is because we do not want to buy when the momentum has already been to the upside for a while and may therefore exhaust itself.
The second trigger occurs a few hours later at 1.1945. We enter the position and place our initial stop at the five-bar low from entry, which is 1.1917. Our first target is two times our risk of 28 pips (1.1945-1.1917), or 56 pips, putting our target at 1.2001. The target gets hit at 11am EST the next day. We then move our stop to breakeven and look to exit the second half of the position when the price trades below the 50-hour SMA by 10 pips. This occurs on March 20, 2006 at 10am EST, at which time the second half of the position is closed at 1.2165 for a total trade profit of 138 pips.
Figure 1: Moving Average MACD Combo, EUR/USD |
Source: FXtrek Intellichart |
Figure 2 |
Source: FXtrek Intellichart |
Figure 3: Moving Average MACD Combo, USD/JPY |
Source: FXtrek Intellichart |
Figure 4: Moving Average MACD Combo, AUD/USD |
Source: FXtrek Intellichart |
On April 25, 2005, we saw EUR/JPY break below the 50-day and 100-day SMA. We check to see that the MACD is also negative, confirming that momentum has moved to the downside. We enter into a short position at 10 pips below the closest moving average (100-day SMA) or 137.76. The initial stop is placed at the highest high of the past five bars, which is 140.47. This means that we are risking 271 pips. Our first target is two times risk (542 pips) or 132.34. The first target is hit a little more than a month later on June 2, 2005. At this time, we move our stop on the remaining half to breakeven and look to exit it when the price trades above the 50-day SMA by 10 pips. The moving average is breached to the top side on June 30, 2005, and we exit at 134.21. We exit the rest of the position at that time for a total trade profit of 448 pips.
Figure 5: Moving Average MACD Combo, EUR/JPY |
Source: FXtrek Intellichart |
When the Strategy Fails
This strategy is far from foolproof. As with many trend-trading strategies, it works best on currencies or time frames that trend well. Therefore, it is difficult to implement this strategy on currencies that are typically range bound, like EUR/GBP.
Figure 6 shows an example of the strategy's failure. The price breaks below the 50- and 100-hour SMA in EUR/GBP on March 7, 2006, by 10 pips. The MACD is negative at the time, so we go short 10 pips below the moving average at 0.6840. The stop is placed at the highest high of the past five bars, which is 0.6860. This makes our risk 20 pips, which means that our first take-profit level is two times the risk, or 0.6800.
Figure 6: Moving Average MACD Combo, EUR/GBP |
Source: FXtrek Intellicharts |
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