Forex Trading Strategy for Trending Markets
The Forex market is well-known for its big trends. While consolidations and sideways moves are also present, trends are usually very powerful and can last for days, weeks, or even months. That is one of the primary reason why I never recommend traders to trade against a price trend, unless there's significant evidence of a reversal. Having a Forex trading strategy that includes that principle is crucial!
“How can a trader benefit from those strong trends?”, you may ask. The answer is simple: by adopting a Forex trading strategy specifically designed for trends. That's exactly what this article is about. I want to share with you one of my best trading strategy so that you can implement it yourself.
A Complete Forex Trading Strategy For Huge Gains In Strong Trends
The strategy described in this article has been taken from Ed Ponsi's book called Forex Patterns And Probabilities.
Most aspiring traders believe they can get on the market and trade with a trading strategy. However, this is not the way it works. The trading strategy I am about to show you will work only some of the times, which brings us to the very first (critical) step in this strategy.
Step 1: Identifying a trend
There are several tools that can be used to identify a trade. Power Trader goes in depth over those tools. For now, I will keep it simple by using Moving Averages.
The idea is that when a currency pair trades below a certain Moving Average, the trend is down. Inversely, once the pair trades above the same Moving Average, the trend is up.
For a trend to be strong, we want to have both the short-term and long-term price action heading in the same direction. That is verified by looking at more than one moving average.
Here are the criteria to identify an uptrend:
- 10 EMA > 20 EMA > 50 EMA > 200 EMA
Here are the criteria to identify a downtrend:
- 10 EMA < 20 EMA < 50 EMA < 200 EMA
To make everything clear, here's an example:
Starting from the red vertical line, the Exponential Moving Average are in the proper order. The 10 EMA (blue) is above the 20 EMA (green), which is above the 50 EMA (red), which is above the 200 EMA (yellow).
Step 2: Confirming the trend
Once the trend direction is identified and we made sure of its strength, we want to make sure that the moving averages are being respected.
Many traders use moving averages without asking themselves whether they are being respected – or looked at – by traders. A crucial part of any Forex trading strategy is to make sure that the tools being used are respected by traders.
In this case, it is fairly simple. Once the moving averages are in the right order, we want to see 10 candlesticks closing above the 10 EMA. Since this Forex trading strategy is used only on the Daily chart, we are looking for 10 days during which the price closed above the 10-period Exponential Moving Average.
To ensure your closing price is appropriate, you might want to select a broker using the New York Close charts (5 daily candlesticks per week).
Here's the same chart as before:
That being said, we now have a strong trend and we know that buyers are putting pressure to keep the price above the 10 EMA. We are now ready to place an entry order.
Step 3: Placing an entry
While an undisciplined Forex trader would buy straight when the trend is confirmed, a professional trader would wait until he gets the right price. In other words, he would wait for a pullback or a retracement.
In this trading strategy, we consider a pullback or retracement to be a move to the 10 EMA. As a result, an entry order is placed at the 10 EMA value.
On the example given, the entry is triggered on the next candlestick as the price was already near the moving average. However, in most cases, the entry would have to be adjusted daily to reflect the 10 EMA change. If the EMA were to increase, the entry would be moved up as well.
While the entry is being placed, a stop loss MUST ALWAYS be added. Step 4 goes more in depth.
Here's what it looks like:
On the graph above, the arrow shows the candle that would have triggered the trade.
Step 4: Planning an exit
The main goal in this strategy is to stay in the trade as long as the trend holds and remains strong. At the same time, we can't stay in a losing trade too long. In this Forex trading strategy, no take profit is set. However, a stop loss will be trailed at the close of every daily candlestick. I'll get to that in a moment…
Before, let me introduce an indicator: the Average True Range (ATR).
I'll skip the details but I do want you to know that this indicator represents volatility. The ATR displays the average range (difference between the high and the low) over the past x periods. The default number of periods is 14.
I see a lot of traders entering trades with a fixed stop loss of 50 pips, for instance. The problem is, that doesn't consider how much a given currency pair moves in a day. By using the ATR, we can overcome that.
If the ATR value is 0.0153, it means that the average movement during one candlestick (one day) is 153 pips. While that would a big stop loss, we can assume that, if we are right, price won't go more than 1/2 of the ATR against us.
The stop loss must be calculated that way:
- Buy trade: 10 EMA – 1/2 ATR
- Sell trade: 10EMA + 1/2 ATR
Here's the same example as before:
The value of the ATR is 0.0153 and the Moving Average is at 1.90115. Therefore, the stop loss is placed to 1.8935.
The key consists of updating the stop loss at every daily candle close. However, never increase the size of your stop loss if the price goes in the opposite direction. You can reduce your risk, but not increase it! You'll see that soon, the risk on the trade you entered will be eliminated.
At the next day's close, the 10 EMA is at 1.90138 and the ATR value is still 0.0153. The new stop loss would be 1.89373.
The day after, the 10 EMA is at 1.90286 and the ATR value is still 0.0156. The new stop loss would be 1.89506.
A losing trade…
Now, if you looked carefully at the chart above, you'll notice that a bearish Engulfing candle formed. It is not super strong but it hit the stop loss at 1.89822. By moving the stop loss in the previous days, we've been able to reduce out loss from 76.5 pips to 29.3 pips. Great!
Don't forget that the moving averages are still aligned correctly. Therefore, the only thing we need is to wait for 10 candlesticks to close above the 10 EMA. We would then replace an entry at the 10 EMA value.
This leads me to discuss the win rate ratio…
According to what I tested, this Forex trading strategy (no other market) is profitable about 50% of the time. In other words, if you were to take 2 trades, you would lose one. However, if you use the method described above to calculate your stop loss and trail it, you'll get HUGE winning trades!
Your losses are going to be limited to a few pips and your winning trades are going to be impressive.
Let's see another example with the same chart as before:
Just a few days later, a trader could have entered (arrow pointing upward). By trailing his stop loss, he would have been able to make roughly 860 pips! Although his stop loss would have been “almost hit” at a few occasion, the trade would have been risk-free not long after entering it.
Of course the trade would have taken a long time to get closed (29 days), but the management is low maintenance.
I presented you a very simple way to benefit from the strong trends forming in the currency market. This Forex trading strategy do not require much work since it is traded on a daily chart. However, like for any other trading strategy, you cannot expect to be right all the time.
The aspect that will differentiate you from all other aspiring traders out there is if you actually implement what's in this article. If you do, and stick to the rules, you'll see great results. If you don't, you'll have to figure out another way. I'm always there to bring you value.
Make sure, if you start trading this strategy that you know how it works and that it fits your style.