How to Create a Trend Following Strategy?

What Is a Trend Following Trading Strategy?

FX Signals – To build an effective trend trading strategy, you need to know how to trade with the trend. Trend trading in Forex is a popular trading style for traders who take advantage of prices moving in one way for a prolonged period. When trading in a trending market, a trader needs to be very careful and pay attention to any signs of the upcoming reversal, which will most likely ruin their setup. One of the greatest trend traders of all time is George Soros, whose trend following trading strategies helped him predict market mood changes.

Popular Chart Indicators

Trading instruments

Trading instruments

Benefits of a Trend Following Method

Trend following trading has multiple advantages over other trading styles. What are the main pros of using this approach?

  • Trend trading can lead to bigger gains. If you follow a trend, you can remain in a winning position as long as possible. Therefore, you will maximize the results of your trades. Trend-followers can adjust the standard risk-reward ratio of 1:3 and raise it to 1:4 or even higher, depending on the trend’s strength.
  • Trading the Trend Lines Guide
  • Trend trading has lower transaction costs. Unlike scalping, trend trading does not require opening tens of positions. This way, you save money because you don’t spend on commissions and spreads for every trade you open.
  • Trend trading saves time. On average, traders need 1-2 hours to monitor the charts and check their trading portfolios when they trade a trend. Trades may run for days or even weeks if the trend is strong. As a result, you have time for other activities.

Does Trend Following Work in Stocks?

Whether you trade on the stock, commodity, or Forex markets, dealing with the trend strategies requires the same rules of technical analysis for all of them. Trends can be found on any chart, so you can try trend following strategy on any instrument you like.

Who are famous trend traders?

Successful trend traders managed to make billions of dollars with their trend trading skills, tactics, and knowledge of the market structure. We’ve already highlighted George Soros as one of the influencers of a trend trading approach. However, there are more people we can mention.

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One of the big names of trend trading is Ed Seykota. He is one of the traders who was interviewed in “Market Wizards” by Jack Schwager. With only $5 thousand in his pocket, he managed to make $15 million over 12 years.

Trend Following Trading Strategy Guide

Another legend of trend trading is David Harding, the CEO of Winton Capital. His trend following fund for clients exceeds $30 billion in assets.

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Finally, you have heard about the hero of the “Reminiscences of a Stock Operator” book Jesse Livermore. Some traders name him as a farther of the trend following approach. In 1929, he had $100 million. In today’s money, that’s about $1.5 billion. His sense of market was so impressive that he still inspires traders until now.

These are some of the most recognized trend following traders, who turned their power and skills into money. Maybe you will be the next to join the list?

How to Construct a Trend Following Trading Strategy?

The first step in building a trend following a trading strategy is the most obvious – you need to determine a trend. You can do it either manually or with the help of indicators.

People with an experience in trading can spot a trend in a blink of an eye! The easiest way to do that is to connect highs and lows. You need to connect at least two points on the chart. If the price forms higher highs and higher lows, a trader can suggest that it moves within an uptrend. Vice versa, if the price forms lower lows and lower highs – you are facing a downward pressure, which will likely start a downtrend.

How to Create a Trend Following Strategy?

Trend Trading with Moving Averages

Most trend traders prefer building trend-following systems rather than using raw price charts. These complex setups include implementing technical indicators to the chart. There are several trend following indicators that can help you with that. The most popular is moving averages. There are simple, exponential, linear weighted, and smoothed moving averages. They all use different math functions behind them.

Simple moving average (MA) is the most popular type of moving average. It shows the average prices for the considered period.

Exponential MA and Linear Weighted MA calculate the latest prices with the higher coefficient. They tend to provide faster signals. However, they may provide lagging information, be careful!

Smoothed MA is based on the simple MA. It clears price moves from fluctuations the most.

The best moving averages for identifying trends are simple and smoothed moving averages. A trader can set different periods of MAs for trend analysis. Typically, a trader sticks to the 200-period simple moving average. It shows the directional bias of the market. A classic interpretation of trend trading strategy with a 200-period simple moving average is straightforward. If the price is moving above the moving average, it indicates an upside momentum. In this case, you need to consider long entries. Vice versa, when the price goes below the 200-period SMA, you are most certainly facing a downtrend.

Trend Intensity Indicator

Trend Intensity Indicato

How to Create a Trend Following Strategy?

On the daily chart of EURUSD above, you can see that the price was forming higher highs and higher lows when it was above the moving average. Alternatively, it was making lower lows and lower peaks when it was below the moving average.

Trend Intensity Indicator

There is another indicator that serves as a powerful helper when it comes to working with trends. It is the Trend intensity index (TTI) that M. H. Pee developed to measure the strength of a trend in the market. It compares the proportion of prices for the previous 30 days above or below today’s 60-day moving average.

It takes today’s 60-day MA and each day’s deviation for calculations. The deviations are calculated as the difference between the close price and the average. Up deviations give a positive amount while the downside deviations give negative amounts. The formula for the TII indicator looks like this:

Trend intensity index (TII) = (total up / (total up + total down)) × 100

The Trend Intensity indicator balances between 0 and 100. If the TII value is below 50, the trend is bearish. When it moves near 20, the downtrend is strong. On contrary, if TII is above 50, the trend is bullish. The closer the indicator is to 80, the stronger an uptrend. You can download the Trend intensity index for Metatrader 5 from the official website of MQL5.

How to Create a Trend Following Strategy?