Trading 101: Trend Following Trading – A Strategy Revealed
Trend following trading is a concept we have covered previously here on Hacked, and even revealed specific trend following strategies you can use. In this article, I will go through some more specifics on how you can profit from trends with the help of technical indicators.
My first introduction to trend trading was through Michael Covel’s book Trend Following. Although Covel is a strong proponent for longer term trend following, the same principles can be applied to shorter term trading as well. The book is a great introduction to a whole new philosophy of trading and investing where you learn to be humble, put your ego aside, and follow the underlying currents of the almighty market.
As a purely technical trading strategy, trend following does not take into account fundamentals, or news that might impact the price, nor does it seek to predict where the price is going. Instead, trend following traders simply react to what is happening with the only variable they care about – price. In fact, trend followers may actually be wise to stay away from the market during major news events, and instead enter again after the new trend has established itself.
Trends always move in waves, which is something many shorter term trend traders are trying to take advantage of. Just as Elliot Wave Theory attempts to do, if you can find a way to identify these waves, buying near the dip of the wave and selling near the top, you can potentially earn lots of money.
The same concept can also be explained as buying in an area of value on the chart, as shown with red circles on the chart below.
In this specific example, you can see that the MA20 line is acting as a support line for the price. Buying in an area of value simply means buying at a point along the trend where you are near the dip of the trend wave, instead of at the top of the wave. Following this principle dramatically increases your chances of success in trend following trading.
The MA-CCI Strategy
This is exactly what the strategy I am going to show you attempts to do with the help of technical indicators. I have named it the MA-CCI Strategy, and this is a strategy that I myself have traded profitably in the past. As you may have guessed, this strategy uses a combination of two technical indicators, the Moving Average indicator and the Commodity Channel Index, to generate buy or sell signals.
What you need to do:
- Choose the instrument you want to trade and select the timeframe you trade on. I usually trade on the 4H for forex and 1H for stocks, but the strategy can really be applied to any timeframe.
- Use a candlestick chart.
- Apply the 20 and 40 Simple Moving Average (SMA) indicator to the chart
- Apply the Commodity Channel Index indicator (CCI) to the chart, with the ‘Length’ setting set to 5.
Strategy conditions for buy (long entry):
- Both 20 and 40 SMA is sloping upwards
- 20 SMA is above 40 SMA
- CCI < -100
- The low of the candlestick touches or goes below 20 SMA
- The close of the candlestick is above 40 SMA.
- BUY TRIGGER: Buy when price is 1 pip above prior candlestick high.
- INITIAL STOP-LOSS: 1 pip below prior candlestick low
- TRAILING STOP: 1.5 Average True Range (ATR)*
*You can experiment with different parameters for your ATR trailing stop, but I like to use 1.5. 1 or 2 ATR may also work well for you. The period setting should be set to 14. TradingView has a built-in indicator called ’Average True Range Trailing Stops’, which can be helpful for this.
Staying true to the trend following mindset, I always hold the trade until I get stopped out by the trailing stop, simply because I have no idea when the trend is going to end. I therefore choose to hold on to the trade until the market tells me that the trend has ended, as per my pre-determined definition (1.5 ATR).
Here is an example of a trade in Palladium / US Dollar (XPDUSD) that I just spotted with this strategy. The green vertical line is my buy and the red vertical line is my sell.
As you can see, we had a situation where price was below the 20 SMA while the CCI indicator was below -100. I then waited for the price to break above the high of the previous candle before I placed my buy order. That was a nice 5.50% gain in 4 trading days.
Do visual back-testing
Instead of buying expensive software or hiring a coder to run back-tests for you, I recommend going over the charts of the instruments you trade frequently and see for yourself if this set-up works for you or not. The MA-CCI setup is easy to spot in most instruments, and you can quickly get a feel for whether this strategy is something you want try for yourself.
One final piece of advice for any kind of trend following strategy is to seek to avoid range-bound markets, and instead always look out for markets that are clearly trending, for example following major news announcements or other stories that can be expected to impact prices over a longer period of time.
Featured image from Pixabay.