That trend following is one of the most profitable strategies is well-known and easily understood by a majority of traders. That it can create remarkably consistent returns over a long period of time is well-established by the track record and testimony of a number of successful and popular traders. Yet in spite of all its advantages, trend following is not a risk-free strategy. Instead, reckless behaviour has the potential to wipe out a trader’s account fast because the sharp short-term swings in the price action are very much capable of erasing highly leveraged accounts in a short period of time. So how can a trader exploit a trending market best? What are the best tools that can be used for forex traders in analysing and exploiting a trend? We’ll take a look at these important topics in this article.
One can recognize trends through both simple visual means, and also by relatively more complicated, but still simple technical or fundamental methods. In both cases, success will depend on one’s ability to isolate the noise from the signal: markets rarely present a trend on a gold plate, instead it is disguised amidst a large amount of secondary fluctuations that have no significance for the overall thrust of the price action, but are nonetheless important for short-term profit-loss adjustment, and risk management.
The most popular technical tools for trend analysis are trend lines, and moving averages. Both classes of indicators are simple enough to allow the quick identification of trends, and both can be constructed and evaluated with relative ease. On longer term charts, an 100-period moving average is probably the best tool for identifying a strong underlying trend that remains alive even as numerous fluctuations disturb the picture. Trend lines are equally useful, but since they must be manually readjusted every once a while, there is a degree of arbitrariness that might not be very attractive to beginners. Technical tools cannot establish the causes of trends, and so they must be used with a degree of common sense, and level-headedness in order to make sure that we can avoid periods of excessive gains and losses.
Fundamental forex analysis requires a longer time frame to establish ongoing trends, but once the signals are in place, the established trends are likely to last longer and remain more powerful and profitable. This is because of the fact that economic events move slowly, and once captured by fundamental analysis, the favorable conditions justifying a trade are likely to be present for a considerable period of time.
The longer a trend lasts, the easier it is to trade. It is not necessarily safer to trade, but a long-term trend allows more mistakes to be made without disastrous consequences, and also makes it easier for part-time traders to exploit favorable scenarios. Short-term or micro-trends, on the other hand, can be difficult to distinguish from volatility, and pose significant problems to the trader who seeks to exploit them while keeping emotional issues out of trading.