06 June, AtoZForex, London – You have probably heard many phrases such as: “Don’t fight the trend,” “Follow the trend,” “Trend is your friend,” etc. but did the same people told how to do so? In this article, therefore, we will discuss strategies and ways how to follow the trend in Forex.
Trend following is not a short term method, therefore, patience, discipline, and determination are necessary. Trends in financial markets are created by powerful underlying technical and fundamental factors.
Three key fundamental economic factors are employment, economic growth, and inflation. For an economy to be successful, the country’s central banks is responsible to ensure that the domestic economy achieves all three factors. Hence, comparing two different central bank views, their current interest rates, and key economic data we could determine a trend of the currency pair fundamentally.
Technically, a trend in Forex market is always determined from a larger timeframe by looking at a bigger picture. Furthermore, we have several tools to help us confirm the underlying trend or warn of a possible trend reversal. The two simple trend following tools that we will discuss are moving averages (MAs) and moving average convergence divergence (MACD).
Although fundamentals and technical play a huge role in determining an instruments direction, both don’t always agree. Since fundamental data is not easily available to everyone and because it can be manipulated, and with increasing influence of technical analysis over fundamental due to EA and global investment bank participation, it is more important to determine the trend technically. This does not mean that fundamentals should be overlooked.
How to follow the trend in Forex
Determining a trend technically – the larger the timeframe, the better the resolution is. That said, timeframes such as monthly are not suitable simple because they lag too much. Hence, we will only be concerned with daily and weekly timeframes.
The main moving averages are 20, 50, 100, and 200. Generally, two MAs per chart are enough, but depending on a strategy more or fewer could be used.
We need to look at three important aspects when analysing a security using moving averages. Their crossover, slope, and price position relative to the SMAs.
Taking an example of 50 and 100 SMAs, if the primer has crossed the 100 SMA to the topside and both MAs are sloping upwards, we can determine that the trend is bullish. Moreover, if the price trends above both 50 and 100 SMAs, the signal is even stronger. An opposite example can be seen in the chart. Note, the above is a simplified way how to follow the trend using moving averages.
Moving average convergence divergence
Using MACD we are only considered about two things. First, do MACD bars form at the top or the bottom side of zero level. Second, do the bars form above or below the trailing MACD average.
From weekly timeframe, an underlying trend can be determined by the position of bars and confirmed by formation of bars relative to the trailing average. If the signals contradict, lets say bars form at the top but below the moving average, this could be a sign of a correction wave.
In addition, MACD convergence, divergence relative to price action could be analysed to predict possible price correction/reversal points.
Similar analysis could be done on a daily timeframe, or simple used for confirmation.
Hope these two methods gave you a general idea about how to follow the trend in Forex. If you would like to see a more detailed description with additional tips and tricks of a particular trend following method, don’t hesitate to contact us via “contact” section.
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