It’s a fact that the majority of retail traders fade large moves and are constantly looking to pick tops and bottoms. The chart below clearly illustrates the concept.
Source: OANDA Historical Position Ratio
On the right hand side, we have the value of UsdCad (Black Line). On the left hand side, we have the net client position (% long – % short, in blue and orange). As you can see, retail clients continue to “catch the falling knives” and remain net buyers as USDCAD continues its decline.
We need to flip this reasoning on it’s head, in order to remain on the correct side of the market. We need to trade in line with clear trends, avoid fading and avoid choppy indecisive markets. And yet, many traders still have trouble trading a clear trend. So in this article we shall review, in order of importance, the keys to trading trends.
Trend Trading Priorities
a) The first step, of course, is identifying clear trends. And to keep things simple and robust, avoid multiple timeframes and focus on a daily chart with at least one full business quarter of activity. If you can’t spot a trend within 10 seconds of opening the chart, then there really isn’t one and you can move on.
Copper is “ugly” for trend trading at the moment.
Crude Oil is a better choice for trend trading currently.
b) the second step is to diversify into clear trends. Most traders trying trend following miss this one core point, which makes all the difference. Trend following on a single instrument is inefficient because most of the time there simply isn’t a good solid trend to follow.
When traders stick to their “preferred currency pairs” or “preferred assets” they are usually lured into sub-optimal trades simply because sitting on hands is a difficult proposition for most. Trends are simply not there all the time, sometimes they reverse quickly. Sometimes this happens to whole asset class. Sometimes the currency markets simply don’t offer much value for trend followers, because the market’s focus in on equities for some reason.
The trick is to at least keep track of indices, energy, metals, bonds, currencies. Follow trends in all asset classes and you’ll win over time.
3) The third step is about risk management. Know your risk limits and split the risk oncorrelated trades. This is a focal point within our Forex System Development Workshop because one of the most common issues we see within the retail world is improper use of leverage. Traders typically trade way too big, and way too often.
Keep your size small, and risk the same % of your equity on each trade. Also, know what maximum drawdown you’re prepared to accept during any given week and don’t break the rules!
4) The fourth step is a bit more tactical: trade the position. Too many traders focus all their attention on obtaining an early entry into the trend. Believe it or not, that’s actually an easy thing to do. But entries, at the end of the day, are not what makes trend trading profitable. First you need to actually know how to spot quality trends in various markets. Then you need to have a solid risk management framework to keep you alive during the tough times.
Then you need to squeeze maximum value out of your trades. This is a bit different from what the systematic trend-followers do. The outfits like Dunn Capital or Millburn just tend to rebalance their positions on a monthly basis. As active traders, with typically shorter time horizons, we need to maximize those situations when the market behaves well.
We’ve already spoken about compounding into a trend and we will be writing a separate blog post on trading the position. For now, just try to adopt the correct mindset:
Get in the market using whatever setups you adopt. Scale out at the first zone of potential resistance/support. Then, on the next viable entry, add back to the position. On the next trouble area, reduce exposure.
By doing this, you are attempting to squeeze some value out of the market’s swings, and by doing so you are in fact protecting the initial entry by lowering the average holding price. This is a tough practice, but the best traders have taught themselves how to do it.
5) Entry. We’ve already demonstrated how, in trend trading, the entry is the least important part of the puzzle. As long as you’re consistent with your method, the entry remains the least important part of your trading strategy in the long term. Just pick one (for example breakouts from persistent market types) and stick with it!
Over to You
Keep things simple, when trading the markets. Know how much importance to attribute to the various pieces of your trading strategy. But also understand that you’re not alone. If you continue to find difficulties, and just can’t achieve consistency, then get in touch with us. It’s really not worth wasting years on end, in the pursuit of trading profits.
by | Jun 21, 2017 – 10.51 am
About the Author
Justin is a Forex trader and Coach. He is co-owner of www.fxrenew.com, a provider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.