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How To Trade Trends In Forex – A Complete Guide
We’ve all heard the saying “The trend is your friend”, and while it sounds nice it doesn’t really teach us anything about trading a trending market or how to identify one. In today’s lesson, I am going to give you guys some solid information on trend trading that you can begin using immediately. Today’s lesson is all about trading trending markets with price action, and we are going to talk about how to tell when a market is trending and how to take advantage of these trends.
I hope you guys pay close attention to today’s article and refer back to it when you have any questions about how to trade or identify a trending market. In fact, if you email me asking about trends…I will probably refer you to this article!
Let’s get started…
The first step: Learn to identify a trend with nothing but raw price action
As you probably already know, there are tons of different indicators that you can put on your charts to ‘help’ you identify a trending market and trade with it. Many traders spend countless hours and dollars on trend-following trading systems or on indicators that just end up confusing them and making the process of trend discovery a lot more difficult than it needs to be.
I have always been a strong proponent of visual observation of the raw price action of a market, as you probably know. I also believe that simply observing a market’s raw price action, from left to right, is the easiest and most effective way to identify a trend and to spot high-probability entries within it.
Let me make a quick note before we proceed: A trend is not actually a strategy by itself; it’s just an added point of confluence that increases the probability of a trade. However, just randomly jumping in with a trending market is not an edge or a strategy.
As a market moves higher or lower, its previous turning points, or swing points as I like to call them, become reference points that we can use to help us determine the trend of a market. The most basic way to identify a trend is to check and see if a market is making a pattern of higher highs and higher lows for an uptrend, or lower highs and lower lows for a downtrend. This is just plain old visual observation of a market’s naturally occurring price action…no mumbo-jumbo trading systems or magic-bullets here. I’d like you guys to take a look at this simple diagram that I drew below; it shows us the basic idea of looking for higher highs (HH) and higher lows (HL) for uptrends and lower highs (LH) and lower lows (LL) for downtrends:
Note: each colored circle is highlighting what we would consider a ‘swing point’ in the market:
Thus, general observation of a market’s swing points is the first point of call in determining if a market is trending. If you do not see a pattern of HH HL or LH LL, but instead you see sideways price movement with no obvious general up or down direction to it, then you are probably looking at a range-bound market or one that is simply chopping back and forth.
Tip: You shouldn’t have to think too hard about whether a market is trending or not. Most traders make trend discovery WAY too difficult. If you take a common sense and patient approach, it’s usually fairly obvious if a market is trending or not just by looking at the raw price action of its chart, from left to right. Make sure you mark the swing points on your chart, as it will draw your attention to them and help you see if there’s a pattern of HH and HL or LH and LL, as discussed above.
Characteristics of trending markets
Trending markets tend to make strong moves in the direction of the trend followed by periods of consolidation or a counter-trend retrace before the next leg in the direction of the trend. You will notice this pattern happens in almost any trend you can find. Typically, what happens to many traders is that they will make some money during the periods of strong directional trend movement, but then they continue to trade as the market takes a breather from the trend and consolidates. It’s these periods when traders give up all of the gains they just made when the market was moving aggressively.
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You need to learn to identify the different parts of a trend, this will help you avoid over-trading during the choppy / consolidation periods and will give you a better chance at profiting when the trend makes a strong move.
Here is an example of what I’m talking about:
In the diagram above, we can see that a trending market tends to move in spurts, moving in the direction of the trend and then stalling to take a breath before another leg in the direction of the trend. Now, all trends are obviously not exactly the same, but we do typically see the general pattern described above; a forceful move in the direction of the trend followed by a period of consolidation or a retracement in the opposite direction.
Now, these retraces are when we have the highest potential for a high probability entry within the trend. Often, a market will retrace to approximately the level of its previous swing point before the trend resumes. In an uptrend these swing points are support and in downtrends they are resistance. Look at the very first diagram in this article for a quick refresher on what I’m talking about. Also, let’s look at the chart we just looked at but this time with the support levels marked. These support levels resulted after the market began to retrace lower within the structure of the broader uptrend.
Note the ‘stepping’ pattern left behind by the swing points in this uptrend. As the market retraces back down to these ‘steps’ or support levels, we would focus our attention and watch for price action signals forming near these levels to rejoin the uptrend:
Note: These same principles apply in a down trending market but we would be looking for price action setups from resistance rather than support.
As we discussed previously, a trending market will tend to surge in one direction and then slow down and either consolidate in a sideways manner or retrace lower or higher, depending on what direction the dominant trend is. It is during these contraction or retrace moves that we can focus extra hard through our ‘sniper-scope’ and begin searching for high-probability price action trading strategies forming from previous swing points within the overall trend.
Trading from value in trends
My primary mission as a price action trader is to watch for obvious price action setups that form after a market retraces back to a confluent level in the market. This can be a swing point like we discussed above, a moving average level, or some other support or resistance level. Whatever the case, I am looking to trade from ‘value’ in a trending market. By value, I mean from an optimum point in the market that has proved significant before.
For example, in an uptrend I would consider ‘value’ to be support, since that is where the price of the market is likely to be seen as a good ‘value’ for the bulls, and thus they will tend to buy from that level and push the price higher. Whereas, in a downtrend, ‘value’ is seen at resistance, since the price has rotated higher within the broader downtrend; so it’s a good ‘value’ to sell from resistance in a downtrend. These rotations back to value points can also be called ‘trading from the mean’ or the ‘average’ price, this is why moving averages tend to act as dynamic support or resistance levels.
One tool we can use to find ‘value’ in a market is a moving average. I don’t use them all the time, but when I do I like to use the 8 and 21 day exponential moving averages. I use them as a general guide and a helper to find confluent points in a market. For example, often the 21 day EMA will align with a swing point in a trending market, this would be considered a confluent level since you have multiple factors lining up together. Then, if we see a price action signal there, we know we are seeing a setup form in a very high-probability area on the chart. See here:
Note: these moving averages should only be used as a ‘general guide’ and never as an actual signal (as in the old ‘moving average crossover signal’). We only use them as a helper to see dynamic support and resistance levels (to add confluence) and for trend direction. But just to be clear, our main focus is on visual observation of a market’s price action and levels, that is to say without any EMAs.
Don’t fall into the ‘breakout’ trap – Many amateur traders get stuck in a cycle of trying to trade breakouts all the time…this is not really an effective long-term strategy because the ‘big boys’ all know that amateurs are constantly trying to buy and sell breakouts. Instead, we want to enter closer to key market levels, swing points, EMA levels (confluent levels) in the market…always with confirmation from a price action signal. As a ‘regressive’ price action trader, we are looking to buy or sell from value within the trend…waiting for the inevitable pullback and then pouncing on an obvious price action signal if one forms.
Forex trends vs. other markets
One aspect of trend trading that I want to touch on briefly is that trends in Forex tend to differ from those in other markets, especially equities.
In Forex, bearish and bullish trends are typically equally as violent and potent…whereas in equity markets we tend to see slower moving price action in a bull market, along with lower volatility. Down-trending markets tend to be fast and volatile in equity markets. Forex trends tend to be the same in their volatility and price action whether the trend is up or down. The main reason is because it’s one currency against another in any given currency pair and this results in more balanced price movement.
Thus, in Forex, your trading strategy and plan will generally be the same for both up and down markets. Here’s an example of the EURAUD daily chart recently that shows just how consistent both down trends and up trends can be in this market…note how the volatility and speed of these trends were about the same:
In the equity markets, traders typically need to adjust their strategies or systems as a market moves from bull to bear or vice versa. But in Forex, whether you’re trading long or short, bull or bear, the volatility of a currency pair tends to say about the same. That’s not to say that volatility never changes in Forex, it just means that the particular direction of a Forex pair doesn’t have a very big impact on that pair’s volatility or price action, as it does in the equity markets for example.
Final notes on trading with trends:
Take advantage of trends when they happen – There is never anything concrete with trends…meaning you never know how long they will last for, so try to take advantage of them when they do occur. Markets typically only trend about 25 to 35% of the time, and the rest of the time they are range-bound or chopping in a sideways fashion. The trick is to learn how to identify a trending market so that you can get the most out of it and get on board as early as possible.
Counter-trend trading – Overall, trend trading should make up about 70% of the trades you take, and the other 30% might consist of counter-trend trades or trades in range-bound markets. It’s best to learn how to trade with near-term trend before you try trading counter-trend, because trading with the trend is naturally higher-probability than trading against it.
In conclusion, trend trading is perhaps the ‘easiest’ way to make money in the forex markets. Unfortunately, markets don’t trend all the time, and it’s the time in between trends that traders do the most damage to themselves. This damage is a result of not having the discipline to wait for high-probability setups to appear, and not being able to properly read a market’s price action to determine whether or not it’s trending.
I trust that today’s lesson has helped you get an idea of how to determine whether a market is trending or not and how to trade a trending market. Remember, there’s no ‘Holy-Grail’ for trend trading, but if you’re in doubt, the best thing to do is to just relax and take some time to visually observe the last few weeks of price data in a market…without indicators. This no-nonsense approach is hard to beat and will work if you know what you’re looking for.
Finally, I leave you with this little formula:
The Best Trades = Trend + Confluent level + Price action signal
I’ve touched on some topics that traders can use for short-term trend analysis today, and I expand on these topics in the members’ article section of my price action traders’ community. Trend following is a large part of my Price Action Forex Trading Course and of my general trading strategy. I’d really love to hear your feedback today, so please remember to leave your comments below & click the ‘like button’.
Four Consistent Ways to Take Profits When Trading (Exit Strategies)
Most day and swing traders spend more time planning and contemplating entries than exits. While proper entries are important, most seasoned traders agree that trading success relies on how a trader exits their trades. Below, learn four exit methods you can use to attain a profitable edge in your trading. If we don’t know how and when to take profits, even a fantastic entry may be squandered.
Which of these exit methods to use is ultimately up to you, based on which ones result in the best performance for your account. I use three of these methods, depending on the trade and market conditions. Compare the different techniques in a demo account, or look at your past trades and see if one method would have produced much better results than the others. Obviously, you want to go with the one that works best for you. Using any of the methods means you will be implementing the same approach each time you exit a trade, which translates to more consistent performance because you won’t be second-guessing yourself and wondering if it is time to take profits or not.
Pre-Determined Reward:Risk Exit
One of the most successful ways, based on my trading experience, for determining exit points is to look at the reward:risk ratio of any trade. Applying a reward:risk ratio ensures well calibrated and pre-set exit points. If the trade doesn’t provide a favorable reward:risk, the trade is avoided, which helps eliminate low-quality trades from being taken. If the target (the “reward” portion of the trade) is reached on a trade, then the position is closed at the target price according to the strategy. If the stop loss is reached (the “risk” portion of the trade) then the manageable loss is accepted, and the trade is closed before the loss gets worse. There is no confusion on what to do: exit as planned, at the predetermined exit points, whether profitable or unprofitable.
In my own trading, I like to have at least a 1.5:1 reward:risk for day trading, and a greater than 2:1 reward:risk when swing trading. This is the minimum recommended. It’s possible to find setups with ratios of 5:1, or even higher. That means that for every dollar you risk you stand to make five. I determine the reward:risk for each trade before I take it, based on the strength of the trend and how far the price is likely to move in my favor (for additional reading on how to analyze trends, see Trading Impulsive and Corrective Waves).
If the using a basic 2:1 formula, then a stop loss placed 100 pips (if forex trading) from the entry point means the target (reward) must be at least 200 pips away from the entry point. With the reward:risk established, and orders set, the trader can sit back and let the trade run until one of these levels is reached and the trade is closed. The chart below provides an example of the reward:risk exit in action.
Source: My Forex Broker, FXOpen
The chart above represents a typical trend trade. The trend is up and I am buying during a pullback. I often wait for the price to consolidate (blue box) for several bars and then buy when the price moves above the high of the consolidation. In this case, the difference between the entry and my stop loss (placed just below the low of the consolidation) is 16 pips. We can see that even if the price only runs to the prior high, or even if it didn’t make it there, it is still possible to have a decent trade because we could have taken profits at 2:1, 3:1 or even 4:1 reward to risk ratios. All of which represent a good return on the risk we were taking.
The reward:risk model is simple and effective, in theory. The challenge comes in making it all work together. For example, the target still needs to be a placed where it is likely to be reached. It doesn’t matter how good the reward:risk is if the price is unlikely to ever reach the profit target. A good target, with a favorable reward:risk, also requires a good entry technique. The entry and stop loss determine the risk part of the equation, so the smaller that risk is–but not soo small that the stop loss gets triggered unnecessarily–the easier is to have a favorable reward:risk.
Sound confusing? Assume you are swing trading and buy a stock at a $50, placing a stop loss at $49. You are risking $1, and even if you placed a target at $53 to $55, that is a pretty reasonable expectation. The price only needs to move 10% to reach $55 (or 2% to hit the stop loss), for a 5:1 reward to risk. Many $50 stocks can move 10% quite easily within a week or two. But, if you buy at $50, and place a stop loss at $45, your risk is $5. Now you need to place a target at $60 or $65 (a 30% move) just to get a 2:1 or 3:1 reward to risk. A much bigger move is required to reach the target. Assume you risk $200 on both these trades. With the first trade, you can much more easily make $600 to $1000 on a conservative upward move. With the latter trade, the price needs to make a big jump just to make $400 or $600 (see Proper Position Sizing for an explanation of how this works).
Let’s look at my forex trade above again, but this time let’s assume I got a much worse entry and used the same stop loss location.
The risk is now 38 pips, so just to get a 2:1 reward:risk I need to put my target 76 pips above my entry. Oops. As we can see, that ended up being too ambitious. The price may eventually make its way up to my target, but I could be in this trade for a long time…and for a small profit. Also, the price rallied in my direction but then pulled back and is trading near the entry point once again. For comparison, on my better entry (chart prior), I could already be out of this trade, have collected my bigger profit, and be looking for other trades.
We want to keep our stop loss (distance from entry) as small as possible, but still out of the way of minor fluctuations, as this will allow us the best chance of taking high reward:risk trades where the target is still likely to get hit. For examples of how this plays out in day trading, see How to Day Trade Forex in 2 Hours or Less, and for swing trading see the Stock Market Swing Trading Video Course.
The name of the game is to find setups that produce high reward:risk ratios, yet only require relatively conservative price moves to produce those ratios.
Multiple Targets and Risk Reduction Exit
Another way to exit a trade is to use multiple targets, and reduce the risk as the targets are reached. Assume a trader opens a position by selling two lots of the EUR/USD. They place a target at 75 pips for the first lot, and a target of 150 pips for the second lot. A stop loss is placed at 30 pips on this particular trade. These are sample figures with the actual numbers varying from trade to trade.
If the price moves 75 pips in our favor, close out half the position at the first target. Then, move the stop loss on the second lot to break even. Even if the price drops to our the stop loss while still holding the second lot, no money is lost and we still have the 75 pips we made on the first lot. If the price continues to move in our favor, then we make 150 pips on the second lot. By staggering our targets we make more (if both targets are hit) than if we just used the 75 pip target for both lots; and by adjusting our stop loss to breakeven after the first target is reached, we reduce our risk and are assured a profit (from the first portion that hit our first target).
This method can be expanded to three targets, or four. Exit 1/3 or 1/4 of the position, respectively, at each target. As each target is reached, move the stop loss to breakeven, then the first target, then the second, then the third.
With this method, we are taking profits as the price moves favorably, but we are also reducing our risk as this occurs because the stop loss moves to the prior target once a new target is filled.
The multiple targets method is easily combined with the reward:risk method described above. In the reward:risk method we picked one target. That works very well if you have practiced and are skilled at picking targets that both maximize profit and are likely to get hit. This isn’t always easy though. Therefore, another option is to exit a portion of the trade at various reward:risk ratios.
Assume you short sell the EURUSD at 1.1510, and place a stop loss at 1.1520. You’re risking 10 pips. Place targets in 10 pip increments below your entry. The first target is 1.1500, then 1.1490, then 1.1480. A third of the position is exited at each of these targets, representing reward to risk ratios of 1:1, 2:1, and 3:1, respectively. This is a simple example, and you may opt to only place targets at 2:1 and 4:1, or 1:1, 3:1 and 6:1.
There are no right or wrongs, rather it is about making the method work for us based on how we trade. With this approach, you may also wish to move your stop loss as targets are reached. When the first target is reached, move the stop loss to the entry. When the second target is hit, move the stop loss to the first target, and so on.
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Trailing Stop Loss
A trailing stop loss is when we move our exit point to lock in profit (or reduce a potential loss) as the price moves favorably. For example, you buy a stock at $50 with a stop loss at $49. When the stock goes to $51, the stop loss moves up to $50. Once a stop loss has been moved up, don’t drop it back down again. If the price keeps rising to $52 the stop loss goes to $51. The price may keep rising, but will eventually pullback enough to hit the stop loss. This is a simple example, and you were already introduced to this concept in the section above.
Trailing stop losses can be quite dynamic though, incorporating statistics or technical indicators. Average True Range (ATR) is a calculation that looks at how far an asset typically moves over the course of one period, on average. That period may be 1-minute, 10-minutes, 1 hour, 1 week….whatever timeframe you have on your chart.
For example, if looking at a daily chart we may see that a forex pair typically moves 50 pips in a day. If we are in a swing trade, on any given day the price could rally or decline, but over time we expect the price to keep moving in the trending direction. Therefore, if we expect the price to go down, we may place a stop loss at 3xATR above our entry price. This means that the price would basically have to rise the equivalent of three days worth of movement to hit our stop loss. That gives our trade lots of room to start moving in our anticipated direction.
The stop loss stays where it is until the price starts dropping like we expect (if going short). This is when we start to implement a trailing stop loss, always keeping the stop loss 3xATR above the current price. Since we are in a short trade, we can only move our stop loss down, never back up. So if the price rises or ATR increases, our stop loss stays where it is.
Keeping track of all this is a pain, but luckily there are indicators that do all the calculations for us. One of my favorite versions of the indicator is called ATR Stops, available on TradingView.com (free real-time charts…although I do pay a yearly subscription to get rid of the ads and have more functionality).
The indicator only requires we input two settings: Period and Multiplier. The Period is how many price bars we want the average of for our ATR calculation. A period between 5 and 14 is standard. I typically use 6 periods with this indicator. For my trading style I find it works the best, although for your trading style you may find another Period setting works a bit better.
The chart below shows this in play. In this case, the settings are 6-Period and a Multiplier of 3.5. I determined the Multiplier setting by looking at the prior rally (rallies) for the asset I am interested in. I find the lowest ATR multiplier that would have kept me in the last rally (even though I wasn’t actually in it) until there was a significant pullback. That gives me a good idea of what settings I need to use for this stock when I do I find a trade setup. In the case below there were two potential entries: a pullback-consolidation breakout and a rounded bottom entry, both of which are covered in my Stock Market Swing Trading Video Course.
Note: settings are a bit different for each stock, forex pair, or futures contract because every one has different volatility. But my Period setting is almost always 6 and my Multiplier setting is almost always somewhere between 2.7 and 3.7. While the settings window is open you can adjust your Multiplier by 0.1 at a time and see the effect.
How to Use the Trailing Stop Loss Indicator
The indicator is below the price, following it up, when the price is rising. When the price falls below the indicator, the line flips above the price following it down as the price falls. Since I like to buy during pullbacks in uptrends (or short during little rallies in downtrends), sometimes the indicator will still be above the price (showing red) when I buy. That is okay. This indicator is not meant to give entry signals, only exit signals. At the time of my trade I still place a stop loss…typically just below the most recent swing low. If the indicator is already below your entry point at the time of a purchase, you can use the indicator as your stop loss level.
If you are long, start using the trailing stop loss once the indicator is below the price. If you are short, start using the trailing stop loss once the indicator is above the price.
The indicator moves with each price bar, so you always know where your exit is before the price reaches it. One option is to exit as soon as the price touches the indicator.
Alternatively, wait for a price bar to close below the indicator line, if in a long trade. Then move your stop loss to just below the low of that price bar. Since I like to trade trends, this gives the price a little more room to start moving in the trending direction again. If you look closely at the chart above, you will see that the price touched the indicator line multiple times on the rally higher…any one of these “touches” could have closed my trade if I opted to use that approach. But no price bars closed below the indicator line and then kept dropping…so I am still in the trade and making more profit. Which approach you opt to use is up to you. There are pros and cons to both.
Do not judge the indicator by how it acts when you are aren’t, or wouldn’t be, in trades. For example, I am mostly a trend trader, and I prefer to focus on strong trends when swing trading. Therefore, I only care about how the indicator performs after a valid trade setup in a strong trending stock. During times when an asset is not trending strongly the indicator will not perform well, as discussed below. That is okay, though, because I am typically not in trades at those choppy times.
And remember, if you are waiting for the price bar to close outside the indicator, just because the indicator flips to red to green (or vice versa) doesn’t necessarily mean you are stopped out. In the chart below the price reverses from an uptrend into a downtrend. Once the downtrend has started I am looking for an entry signal to go short. A signal occurs when the price drops below the small box I have drawn. At the time of the trade, the indicator is below the price. That is fine. I will still go short and place my original stop loss. Once the indicator flips back above the price and I will start using the indicator as a trailing stop loss.
Once the price starts falling, it eventually closes above the indicator line again. We drop our stop loss to just above the high of this bar. On the next bar, the price keeps falling so we are not stopped out. Later on, the price closes above the indicator again. Our stop loss is moved again, in the same fashion. A few bars later the price hits the stop loss and gets us out of the trade, having captured a nice downside move.
At the time this trade was taken, the trend is was not particularly strong. I would call this a “normal” trend. Therefore, I actually I wouldn’t have used a trailing stop loss, rather I would have used the reward:risk method and looked to get in and out a couple of times during this downward move. But the example does illustrate how this particular trailing stop loss method works. Feel free to adjust it to your liking.
Other Trailing Stop Loss Indicators
There are many ways to implement a trailing stop loss, and some indicators may help in this regard.
Some examples of other indicators that could be used as trailing stop loss are Turtle Channels and Envelopes, Bollinger Bands or Keltner Channels, TTM Trend, or even a humble Moving Average.
The trailing stop loss can also be based on price action. For example, you sell a currency pair at 1.2510 and place a stop loss at 1.2525. You are risking 15 pips and trading off of a 5-minute chart. You don’t place any profit targets, but once the price has moved more than 30 pips in your favor (2:1), you start dropping your stop loss to just above the most recent high of every new price bar. As long as each bar keeps dropping, your stop loss drops to lock in more profit. As soon as the price moves above the high of the last bar, you are stopped out and collect your profit. This is just an example, but shows how you can create your own trailing stop loss method.
Pros and Cons of Trailing Stop Losses
I only use trailing stop losses on trades where there is a strong trend. A strong uptrend is when each upward price wave moves well above the last swing high. A strong downtrend is when each downward price wave moves well below the prior swing low. For comparison, in normal uptrends, the price moves a little bit above a prior high before pulling back. In weak uptrends, the price is barely making new highs before pulling back.
During strong trends, the price can move a lot further than we think. The trailing stop loss keeps us in the trade as long as the price is moving well. During choppier conditions, or when the price is in a normal trend, I don’t use a trailing stop loss because it will not work well. Instead, I use the reward:risk method. Before the trade is taken I determine which exit method I will be using, then I stick with it.
So that is the tradeoff: trailing stop losses work well, but usually only in strong trends. The reward:risk method works well all the time, but during very strong trends it is highly likely you will be leaving money on the table. Trying to use a trailing stop loss in choppy conditions–or in weak, or even normal, trends–will likely lead to poor performance…or at least worse performance than if using a properly implemented reward:risk method.
A time-based exit is used in conjunction with other exit methods, and will supersede them in some cases. A time-based exit allows us to close a trade before our target or stop loss is reached, but only under certain conditions. Day traders don’t typically hold overnight positions, so it’s prudent to close all trades, regardless of profit or loss, by the end of the trading day…or whenever the trader decides to quit for the day.
Another time-based exit is to close all positions a couple minutes before a major economic news release (like interest rate announcements). Most day traders and some swing traders do this, and then resume trading after the announcement.
I personally opt to close all my day trades before news announcements. About two minutes before, I just hit the close button on my day trades regardless of profit or loss. Once the news is released, I go back to trading again. On shorter-term swing trades, I also typically close my positions before a major news (for forex) or earnings releases (for stocks). For longer-term trades (like my forex weekly charts method), I leave my trades open and am not concerned about closing them prior to earnings or news releases.
Establish any time constraints you opt to work within, then stick to the rules that you set. Use time-based exits in conjunction with the other exit methods.
Final Thoughts on Taking Profits When Trading
I primarily stick to reward:risk and trailing stop loss exits. For many of my trades, I use the reward:risk (one target) method because I know exactly what I am getting and am happy to risk a certain amount to potentially make more. I use a trailing stop loss only when an asset is in a strong trend. During strong trends the price can run for much longer than I expect. Therefore, I extract more profit by letting it run as far as it wants, then getting out when it starts to pull back and triggers my trailing stop loss. For normal trends, that aren’t exceptionally strong, I find that a well-placed target extracts more profit than the trailing stop loss. That said, placing high-probability targets takes a lot of practice, whereas using a trailing stop loss does not. Find the method that works best for you then stick with it.
Time-based exits make sure we don’t get stuck in a situation we don’t want to be in, such as holding a day trading stock after-hours when liquidity dries up, or holding a position through a major news event that could cause us to lose much more than expected. Longer-term traders don’t need to worry about this as much, but should still be planning their exits using one of the other methods.
Finally, another exit method is to place multiple targets, taking profits as the price moves favorably. This strategy can be a bit easier to implement than picking one target, because we can just place targets at various reward:risk ratios instead of trying to pick one. For example, place a target at a 2:1 reward:risk, another at 3:1, 4:1, etc. The stop loss can also be moved to reduce risk as the targets are reached.
If you are interested in learning a complete method of swing trading stocks, including how to find trades, how to manage risk, where to enter, and where to exit, then check out my Stock Market Swing Trading Video Course. More than 12 hours of video show you how to swing trade efficiently and profitably, in about 20 minutes per day.
Technical Analysis Strategy – Four Candle Hammer Strategy
Technical Analysis Strategy – Four Candle Hammer Strategy
In this article, we’re going to teach you one of our favorite technical analysis strategy. The four candle hammer strategy is a pullback strategy that has been long used by hedge fund managers and professional traders.
Our team at Trading Strategy Guides has decided to bring to light one of the best secrets kept by hedge fund managers that they don’t want you to know.
We used this technical analysis strategy for more than 20 years, and we still find it producing the same kind of performance in today’s market. Technical analysis trading is useful for any type of market from stock trading, Forex trading and, even cryptocurrency trading.
The four candle hammer strategy works both intraday for day traders and for swing traders who tend to hold positions for a more extended period of time. We recommend using the hammer strategy on the daily time frame because it yields bigger profits.
The four candle hammer strategy can be used to take both long and short positions.
This guide will include every step that you need to follow so you have a better understanding on how hedge fund managers trade the market. But first let’s define what is technical analysis, and what it’s not.
Once you understand what is technical analysis, you’ll gain a much better understanding of how to read a chart price. Also, read the weekly trading strategy that will keep you sane.
What is Technical Analysis?
In trading, technical analysis is a method used to forecast the direction of the market price or the strength of the trend by analyzing the past market price. Technical analysis trading focuses on the charts and other technical indicators to forecast the market
The three fundamental principles behind technical analysis basics are as follows:
- Market price action discounts everything. So, wherever the market is trading now that’s the fair market price. All the hopes, fears and market expectations they’re all factored into the price.
- Markets move in trends. The markets take a while to get to wherever they are going to go.
- The third assumption is that history tends to repeat itself so price levels that were vital in the past can often be important in the future.
A technical analysis strategy is not a magic method that’s going to predict every swing in the market. A typical misconception traders have is that technical analysis trading is the answer to getting rich quick which is apparently not the case.
The majority of retail traders will look at technical analysis trading and charts.
Now, let’s don’t waste any more time and jump straight into the hammer strategy rules and how to trade pullbacks or retracements in any type of market.
Technical Analysis Trading – Buy Rules
Moving forward, we’re going to outline a step-by-step process so you can learn how to trade pullbacks in any market in a systematic way. We live by these rules on a daily basis, and we’re confident they will help you execute good trades right from the start. Here is another strategy called trading volume in forex.
The basic concept behind the technical analysis strategy is first to spot a strong market trend followed by a pullback in price. The retracement should only last a short period of time.
Once the market retracement pauses, the trend will resume and continue moving in the direction of the dominant trend.
Essentially the four candle hammer strategy is also a trend following strategy.
Note* Remember to pull out a piece of paper and a pen to write down the technical analysis strategy rules. For this article, we’re going to look at the buy side.
Step #1: The market needs to make a 20-day new high
The first step is to identify the market trend. This makes sense since the four candle hammer strategy is a pullback strategy it needs a prior trend.
The first and most important thing are to identify a strong trend that is moving vigorously up. Identifying strong trends can be done through technical indicators. However, our retracement strategy doesn’t use any technical indicators and rely solely on price action.
Price action is the most accurate way to determine trends and hedge fund managers know this best.
The 20-day high rule is an excellent way to identify markets that are having a strong trend and is it’s rather a simple way to spot the trend.
Note* We’ll demonstrate this trading method on a recent trade so you can see how the pullback strategy works on a life trade.
We can see EUR/USD is in a strong bullish trend, but it’s not overextended but still trading sharply in one direction.
Now, this brings us to the second rule.
Step #2: Identify a 4 day pullback that goes against the prevailing trend.
As a general rule, the second part is to spot a pullback that moves against the prevailing trend. This step is quite important because the pullback will create our entry opportunity before the market starts resuming the prevailing trend.
The four candle hammer strategy will relay again on the price to identify the retracement. Technical analysis trading can be done even without indicators. However, the retracement still needs to satisfy some trading conditions.
Namely, we want to see 4 consecutive days retracement in a row after the 20-day high was put in place.
The next step will also outline our pullback buying strategy.
Step #3: The 5 th day closing price needs to be above the 4 th day closing price
It’s our job to identify when the short-term retracement will end and jump on the wagon before the dominant trend resumes and leaves us in the dust.
On the 5 th day, we’re looking for the market to put an end to the retracement. The upside momentum should pick up on the 5 th day.
The stronger the momentum at this stage, the better.
Note* It’s sufficient for the 5 th day closing price to be above the 4 th day CLOSING price. Please note that we didn’t say the 4 th day HIGHEST price. The rule is that the higher the 5 th day closing price is, the better.
This is a crucial day because it’s the day prior to our possible entry point.
The next part of the four candle hammer strategy is detecting the right spot were to enter the market.
Step #4: Buy at the close of the 5 th day of the pullback
Our retracement strategy is offering us a good entry point that is close to the end of the pullback. This is also the point where the market will begin resuming the primary trend.
In this regard, we buy at the close of the 5 th day of the pullback. Or you can say that we buy at the opening of the 6 th day.
Our entry strategy will help you maximize your profit potential and minimize your risk level.
The next important thing we need to establish for our pullback strategy is where to place our protective stop loss.
Step #5: Place protective Stop Loss 10 pips below the 5 th day low
Usually, the lowest risk trades happen when the retracement of a strong trends end. This is the reason why we’re able to use such a tight stop loss.
Place your protective stop loss 10 pips below the 5 th day low. We’ve added a buffer of 10 pips to protect ourselves in case of any false breakouts.
Note* Remember to always use SL because not using stop loss is the number 1 reason why traders take significant losses.
Last but not least, we also need to define the technical analysis trading methods and techniques for four our take profit level which brings us to the last step of our technical analysis tutorial.
Step #6: Take Profit equals 3 times the distance between your entry price and your stop loss price
The best way to establish your profit targets is to multiply the distance between your entry price and your stop loss price by 3. In other words, we want our profit target to be 3 times greater than our stop loss giving us a positive risk to reward ratio of 1:3.
Note** the above was an example of a BUY trade using technical analysis trading. Use the same rules for a SELL trade – but in reverse. In the figure below, you can see an actual SELL trade example.
Conclusion – Technical Analysis Trading
Many hedge fund managers believe that technical analysis trading has a role and a place in every investor’s toolkit. One of the biggest mistake retail traders make is not looking at the big picture trend, and the four candle hammer strategy capitalizes on this market pitfalls. You can also trade with the breakout triangle strategy.
If you correctly follow this technical analysis strategy guide, then you should have a better understanding of how the market moves and how the smart money operates in the market.
Thank you for reading! Be sure to read more about candlestick trading in the Best Candlestick Strategy Guide.
Please leave a comment below if you have any questions about what is technical analysis!
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