Trend following

Published: 11. January 2024

Many traders use the expression ‘The trend is your friend’, and there is much truth in that. Beginners in trading dream of ‘catching the turns’, thereby reaping the full benefit of a trade by buying exactly at the low point and selling exactly at the maximum profit. But if you want to be successful as a trader, you should forget that dream immediately. Achieving maximum profit in a price cycle is almost impossible. Instead, one can more successfully try to locate a trend, and then ride the wave.

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To locate a trend and a possible entry, you can use the following strategy, which is called the ‘Trend following strategy’.

A. To be sure that you are in a trending market, you can apply three different moving averages to your chart (as a day trader, for example, you can use a 5-minute chart). The EMAs should have three different speeds: 10, 20, and 50. When you see that the three EMAs are aligned with each other, you know you are in a trending market. As extra security, you can supplement your 5-minute chart with a 15-minute or 30-minute chart and similarly apply the three EMAs to the chart. If the longer timeframe shows the same trend, then the trend is going strong. See Figure 1.

Figur 1. De tre glidende gennemsnit er indsat med tre forskellige farver. Sort er hurtig (10), grøn er middelhurtig (20) og blå er langsom (50). Når man befinder sig i et trending-market vil disse tre glidende gennemsnit ligge i forhold til hinanden, så den langsomme ligger tættest på grafen, dernæst den middelhurtige og til sidst den langsomme. Se dette i forhold til figur 3 nederst her på siden.
Figure 1. The three moving averages are inserted in three different colors. Black is fast (10), green is medium-fast (20), and blue is slow (50). When you are in a trending market, these three moving averages will be arranged in relation to each other, so that the slow one is closest to the chart, followed by the medium-fast, and finally the slow one. See this in Figure 3 at the bottom of the page.

B. To determine the momentum in a trend, i.e., how strong the trend is, you can use the indicators RSI and MACD. Momentum is an expression of the buying pressure in an uptrend and the selling pressure in a downtrend. To be sure that we have a solid trend, we want new ‘highs’ on the price chart to also show as new ‘highs’ on RSI and MACD.

If points A and B are fulfilled, you can be reasonably sure that you are in an uptrend. Now you just need to find a good entry point in the market.

Notice how a market, even though it is trending, is still adjusted along the way with small ‘pullbacks’. It is the trader’s task to buy these pullbacks in order to get the best possible price. Typically, you can wait for the price to move down between the fast and the medium-fast moving average

Figur 2. Læg mærke til de små trigger-candles (markeret med cirkel), der kan opstå, når prisen har lavet et kort tilbageløb, dernæst tager en pause og så igen er klar til fortsætte med trenden. Som trader bør du prøve at fange på disse tilbageløb og bruge den lille trigger-candle som entry. De falende toppe i MACD og RSI er her markeret med streger. Kriterierne er dermed opfyldt for en entry ”short” markeret med pil.
Figure 2. Notice the small trigger candles (marked with a circle) that can occur when the price has made a short pullback, then takes a pause, and is again ready to continue with the trend. As a trader, you should try to catch these pullbacks and use the small trigger candle as an entry point. The falling tops in MACD and RSI are marked with lines here. The criteria are thus fulfilled for a ‘short’ entry marked with an arrow.

When you see this pullback, you should wait for a small so-called ‘trigger candle’. This means a small candle that confirms the market has slowed down and is now waiting to decide to continue in the direction of the trend.

Your precise entry now occurs when the next candle surpasses the small trigger candle in the direction of the trend.

figur 3. Eksempel på et marked, hvor de tre EMA'er ikke ligger velordnet. Markedet har ingen trend, og man skal være varsom med at gå en i denne type marked.
Figure 3. Example of a market where the three EMAs are not well-ordered. The market has no trend, and one should be cautious about entering this type of market.

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