Getting Started with Forex Trading

Trading with the Trend: Low Risk High Reward Forex Strategies

Trading with the prevailing trend is one of the most effective ways to profit in the forex market. By identifying and following the overall directional bias, traders can increase their win rate and benefit from large moves in their favor. In this comprehensive guide, we will explore time-tested trend trading strategies, risk management rules, and tips for maximizing rewards relative to risk.

What is Trend Trading?

Trend trading refers to a trading style where traders look to enter trades in the same direction as the prevailing trend. Rather than trying to predict reversals or counter-trend moves, trend traders wait patiently for pullbacks and continuations in order to benefit from the dominant market momentum.

The key advantage of trading with the trend is that it improves the risk reward ratio of trades. Since the overall momentum is working in the trader’s favor, winners tend to be larger than losers. Stop losses can be placed relatively close to entry while profit targets are placed further away. This allows for larger potential gains with smaller potential losses.

Trend trading works on all time frames, from short-term swings lasting hours and days to multi-week and multi-month long-term trends. The keys are identifying a directional bias with confidence and managing trades effectively once entered.

How to Identify the Trend

Here are some of the most common methods used to gauge trend direction in forex:

Price Action Analysis

Analyzing raw price action using candlestick or bar charts allows traders to visually identify trends. Generally, a series of higher highs and higher lows indicates an uptrend while lower lows and lower highs indicate a downtrend. The larger the swings up or down, the stronger the trend.

Price Action Trend

Price action showing a strong uptrend on the 4-hour EUR/USD chart

Moving Averages

Crossovers of moving averages of different lengths help define trends. When shorter MAs cross above longer MAs, it signals an uptrend. Shorter MAs below longer MAs indicate downtrends. The 20 & 50 SMAs are commonly used for trend analysis.

Moving Average Trend

50 SMA (black) crossing above the 100 SMA (red) signals uptrend on EUR/USD Daily chart

Higher Highs and Lows

Connecting swing highs and lows shows the prevailing trend direction. Higher highs and higher lows define uptrends while lower highs and lower lows characterize downtrends. This method works well on all time frames.

Swing Highs Lows Trend

Swing highs and lows showing strong uptrend on GBPAUD daily chart

Moving Average Convergence Divergence (MACD)

The MACD indicator is composed of two exponential moving averages measuring momentum. When the shorter EMA is above the longer EMA, it signals an uptrend. Below indicates downtrends. The centerline crossover defines changes in trend direction.

MACD Trend

MACD trend change signals on EUR/JPY hourly chart

Average Directional Index (ADX)

The ADX measures trend strength on a scale of 0 to 100. Readings above 25 indicate a strong trend while below 20 shows weak or range bound conditions. Traders can use the direction of the ADX +DI/-DI lines to determine bullish/bearish bias.

ADX Trend Strength

ADX reading above 40 indicates strong downtrend, EUR/AUD daily chart

Trend Trading Strategies

Here are some of the most effective forex trend trading strategies to capitalize on sustained momentum.

The Moving Average Trend Surf

This straightforward approach involves using a pair of moving averages to define the trend and identify opportune entries. The entry rule is to go long when the shorter MA crosses above the longer MA and exit longs when the MAs cross down. Short trades are taken when the MAs cross down and exited when the MAs cross up.

  • A 20-50 day SMA combination works well for swing trading the daily chart
  • 8-21 SMAs can define near-term trends on the 4-hour chart
  • 5-13 SMAs pick up hourly trends

Stops are placed just below the recent swing point on buy entries and above the swing high for short entries. Take profits can be set at 2-3x the stop loss.

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Moving Average Trend Surf

Entering as MAs cross and riding uptrend on GBP/JPY daily chart

The Moving Average Pullback

With the pullback method, traders wait for a brief retracement against the dominant trend before entering in the direction of the overall momentum. This involves using the faster MA as an entry trigger rather than using the MA cross as the actual trade signal.

After identifying an uptrend, traders wait for the price to retrace down to the slower MA before buying. The entry is placed as the price starts to rally off the moving average dynamic support. Stop losses go below the pullback low and targets are based on recent swing points.

Moving Average Pullback Entry

Buying the pullback to 20 SMA during uptrend on AUD/USD hourly chart

In downtrends, shorts are taken as the price bounces off the slower MA resistance. Stops go above the pullback high and take profits are placed at logical support areas.

Trendline Breakout / Breakdown

Drawing trendlines connecting swing highs in uptrend and swing lows in downtrend allows identification of support and resistance zones. Traders can look to enter new trend trades as the price breaks support or resistance zones.

In uptrends, buys are triggered when the price breaks above sloped resistance. The stop loss goes below the recent swing low. For downtrends, sells are taken as the price breaks support. Stops are placed above the latest minor high.

Trendline Breakouts

Buying break above trendline and selling break below trendline

Target profits based on recent price swings, fib levels, round numbers or other confluence. Move stops to breakeven once price exceeds 1:1 risk reward.

Using an Oscillator for Overbought / Oversold Extremes

Oscillators like the RSI, Stochastics or CCI reaching overbought or oversold levels can signal exhaustion turning points and trend continuations.

When trading with the trend, overbought can represent a selling opportunity in downtrends and a chance to buy dips in uptrends. Oversold readings can flag buying opportunities in uptrend and selling in downtrends.

Oscillator Overbought Oversold

RSI reaching overbought to signal downtrend pullback opportunity

Divergence between price and the oscillator warns of trend weakness. If the price makes a higher high but the oscillator makes a lower high, it indicates bearish divergence. The opposite shows bullish divergence.

Using Fibonacci Retracements

Fib retracement levels can help identify potential areas of support and resistance for trend pullbacks and continuations. In uptrends, the 23.6%, 38.2%, and 61.8% Fibs often act as support zones to resume the uptrend. In downtrends, these levels become resistance for sells.

Fib Retracements Trend

Fib levels showing potential support and resistance during trend

Buys are triggered when the price bounces off Fib support in uptrends. Shorts are taken when the price hits resistance on bounces in downtrends. Stops go above support or swing highs. Target the next Fib level or recent swing point.

Inside Day Breakout

Inside bars or inside days signal tightening consolidation ahead of a potential breakout with momentum. When a bullish inside day occurs within an uptrend, traders can buy a high probability breakout trade above it. Inside days in downtrend present shorting opportunities on a breakdown.

Inside Day Breakout

Buying break above bullish inside bar in uptrend on EUR/GBP 4-hour chart

Place a tight stop loss below the mother bar low (for longs) or above mother bar high (for shorts). Target a minimum of 1:1 price objective based on the height of mother bar.

Effective Risk Management for Trend Trading

Proper risk management is crucial when trend trading to avoid giving back profits once a trend reverses. Here are some guidelines:

  • Position size appropriately to limit loss on a single trade to 1-2% of capital
  • Use a stop loss on every trade, placed just below key swing low (for longs) or above swing high (for shorts)
  • Trail stops to lock in profits as the trend continues in your favor
  • Take partial profits at levels where a pullback is expected
  • If stopped out, wait for next setup rather than quickly re-entering. Be patient.
  • Avoid averaging down losing trades or throwing good money after bad
  • Be willing to admit when you are wrong and exit a trade if it is not behaving as expected

Disciplined risk management allows you stay in trends longer, maximizing the big winners and cutting losers short before they become excessively painful.

How to Find High Reward Setups

Not all trend trades offer favorable risk vs reward scenarios. Here is how to spot high probability setups:

  • Look for strong, high-momentum trends with long bodies and expanding range
  • Find overextended moves getting overbought/oversold for trend continuation trades
  • Wait for shallow retracements of 38-61% before entering in direction of trend
  • Trade breakouts of clearly defined support and resistance levels
  • Buy/sell after reversal candlestick signals like engulfings, dojis, and pinbars
  • Enter on stochastics/RSI divergences which signal exhaustion turning points

Patience is required for the best trends to develop. Often, the strongest trends persist longer than expected. Avoid trying to pick tops and bottoms prematurely.

Pros and Cons of Trend Trading

Pros of Trading Trends

  • Improves risk vs reward profile of trades
  • Trades in direction of momentum increases probability of success
  • Easy to spot and highly objective
  • Many simple, mechanical strategies work well
  • Can profit from long duration trends

Cons of Trading Trends

  • Requires patience and discipline to wait for optimal entries
  • Carries risk of whip saws and false breakouts
  • Hard to capture exact reversal point
  • Trends can reverse suddenly after long run
  • Not effective in range bound or choppy markets

While trading with the trend has advantages, it still carries inherent trading risks. Have a plan for both trending and non-trending market conditions.

Common Forex Trend Trading Mistakes

Here are some of the biggest mistakes traders make when trend trading:

  • Chasing the trend too late – Traders end up buying tops and selling bottoms by hopping on right as trend exhausts
  • Exiting winners too early – Taking quick profits versus maximizing trend trades
  • Sitting through pullbacks – Not having the patience to withstand normal retracements
  • Overtrading – Overtrading and overmanaging positions rather than letting the trend develop
  • Lack of risk management – Neglecting stops and proper position sizing rules
  • Revenge trading – Re-entering failed trades immediately to try to “get your money back”
  • Lack of plan – Trend trading without a defined strategy, entries, exits and trade management rules

Avoid these common errors through proper education, discipline, and actively trading with an edge. Have reasonable expectations by anticipating normal pullbacks and periods of consolidation within trends.

Frequently Asked Questions on Trading with the Trend

What time frame works best for forex trend trading?

Trends persist across all major time frames. That said, the daily and 4-hour charts generally provide the best balance of readability and tradability for most forex traders. Always trade the time frame that fits your schedule and personality.

How do I determine a market trend?

Use a combination of indicators like moving averages, MACD, ADX and directional price patterns (higher highs/lows, breakouts etc). The more techniques that confirm the trend bias, the higher probability of an accurate trend reading.

When should I enter trades based on the trend?

Look to enter after a minimum retracement of 38-61% within the prevailing trend on your entry time frame. Be patient for these low risk, high reward entries rather than blindly buying strength or weakness.

How much should I risk per trend trade?

Limit risk to 1-2% of account balance per trade. This ensures you can withstand the inevitable failed trades and won’t risk excessive capital on a single uncertain setup. Proper position sizing is vital for long-term trading success.

Where should my stop loss be placed when trend trading?

Place initial stops just below obvious swing points for longs and above swing points for shorts. This ensures you are not stopped out prematurely. Trail stops incrementally to lock in gains once the trend moves in your favor.

How far can I let a winning trade run?

Let your winners run as far as possible until you see a clear technical signal that the trend has reversed. Never exit simply because of an arbitrary profit target. Significant trends can persist longer than most traders expect.

Conclusion

Trading with the dominant trend direction boosts win rate and reward potential for forex traders. By mastering techniques to properly identify and enter trades in harmony with momentum, traders can profitably extract gains from sustained moves. Utilizing effective risk management ensures you can withstand the unavoidable failed trades and volatility associated with any trading style. Patience and discipline are required to maximize gains while keeping losses small.

While trading with the trend has advantages, be prepared for all market conditions by having strategies in place for both trending and range-bound environments. No one style works perfectly at all times. Maintain reasonable expectations, never risk more than you can afford to lose, and work diligently to execute high probability trades in alignment with prevailing market momentum.

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George James

George was born on March 15, 1995 in Chicago, Illinois. From a young age, George was fascinated by international finance and the foreign exchange (forex) market. He studied Economics and Finance at the University of Chicago, graduating in 2017. After college, George worked at a hedge fund as a junior analyst, gaining first-hand experience analyzing currency markets. He eventually realized his true passion was educating novice traders on how to profit in forex. In 2020, George started his blog "Forex Trading for the Beginners" to share forex trading tips, strategies, and insights with beginner traders. His engaging writing style and ability to explain complex forex concepts in simple terms quickly gained him a large readership. Over the next decade, George's blog grew into one of the most popular resources for new forex traders worldwide. He expanded his content into training courses and video tutorials. John also became an influential figure on social media, with over 5000 Twitter followers and 3000 YouTube subscribers. George's trading advice emphasizes risk management, developing a trading plan, and avoiding common beginner mistakes. He also frequently collaborates with other successful forex traders to provide readers with a variety of perspectives and strategies. Now based in New York City, George continues to operate "Forex Trading for the Beginners" as a full-time endeavor. George takes pride in helping newcomers avoid losses and achieve forex trading success.

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