Published on March 14th, 2019 | by admin0
8 Rules to Follow When Using a Trend Following Strategy
As a trader, are many important factors you should be aware of in the financial markets, but the trend is one of the most important. This is because without the trend, it would be almost impossible for traders and investors to make money. Long-term investors like Warren Buffet have made a fortune because most of their holdings have moved in an upward trend. Day traders, on the other hand, succeed when their long trades move up and when their short trades move down. This article will give you eight rules to help you use a trend-following trading strategy.
1. Don’t go against the trend
In the financial talk, it is often said that the trend is your friend to the end. A common mistake that people make is trying to time the market and move against the trend. For example, they will see an asset price which is moving in a strong upwards trend, and open an opposing trade. They do this because they want to be contrarians. They expect to make a profit when the price reverses. Unfortunately, this is often not the case because an asset that is moving up will often continue in the same direction, until major news or some other factor causes a reversal.
2. Don’t trade too early
This means that you should first identify a trend, before you follow it. Sometimes, traders want to open a trade early before knowing if a trend is in progress. While this might be profitable, it also exposes them to the risk of being in a false breakout situation. As the name suggests, a false breakout is when the price of an asset moves above or below a support or resistance level and then retreats to continue with the original trend.
3. Set and forget your trades
Some traders, especially beginners, might open a trade, and then watch it continuously. The problem with this approach is that it brings anxiety to traders, which can lead to suboptimal decisions, and exiting trades with a loss. Instead, it is recommended that you open your trade, set the levels for take profit and stop loss, and then focus on other things.
4. Buy the dips in an uptrend
A trend does not always move in a straight line. In an upward trend, you will often see some minor dips. These dips happen because some buyers exit their trades to take a profit. You should always examine the dips by looking at volume indicators and then buy. The dips will always give you a better price than when you are buying at the top.
5. Sell the rallies in a downtrend
Similar to the previous point, you should strive to sell the rallies that happen in a downward trend. These rallies will give you a better price to add into your short trade. However, it is also important that you have an idea about when the downward trend will end.
6. Cut your loss-making trades
A key principle in trading is that no strategy is ever 100% accurate. Therefore, even in a perfect trend, mistakes are bound to happen. To avoid making losses, it is recommended that you close a trade that is not going as anticipated. A good way to do this is to calculate your risk-reward ratio and then set a trailing stop loss.
7. Use fundamental analysis
Fundamental analysis is the practice of using the news or macroeconomic data to make trading decisions. Often, this economic data can cause a trend to change. For example, if the US Federal Reserve lowers interest rates, there is a likelihood that the dollar will fall. Therefore, before you enter a trade, it is recommended that you study the economic data for that day.
8. Use Fibonacci Retracement Tools
Fibonacci Retracement is a common tool in trend following analysis. The tool was developed by applying the concept of Fibonacci sequence, which was introduced more than a 100 years ago. In trading, it is applied by joining the extreme high and lower levels. This tool is important because it gives you the likely pivot levels in a chart.
The tips above will help you become a better forex trader by using a trend following strategy. If you’re new to currency trading and want to know the basics first, this guide will help you understand what is forex. Lastly, test your trading strategy with a demo account before you try with real money.