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Trend Trading

What is trend trading?

A trend is formed when the price makes higher highs and higher lows (uptrend) or lower highs and lower lows (downtrend)

Here is an example of an uptrend. See how the price makes higher highs and higher lows.

Here is an example of a downtrend. See how the price makes lower highs and lower lows.

So how can you use trends to make money in Forex?

OK, say the market is in an uptrend as per our first diagram. Where would you enter a long trade (buy) based on that trend? If you said either low 1, low 2, or low 3, then you would be correct. These lows are known as pullbacks, or retracements. Entering a trade at a pullback or retracement is the logical place to enter a trade when trend trading.

So moving to our second diagram, where would you enter a short trade (sell) based on that trend? Yes you are correct, you would enter short at high 1, high 2, or high 3.

Now its very easy to look at a historical chart and see the places when you could have entered a trade long or short, but when the market is moving and you are in real time then its not so easy, as you don’t know what is going to happen next. If you knew which way the price was going to move next you would be a very rich man, or woman. 🙂

As you do not know for certain what is going to happen to the price, you have to work on probabilities.
If you draw a straight line connecting the lows in and uptrend, or the highs in a downtrend, you have just drawn a trend line. Drawing an extended trend line will help you see into the future as far as price is concerned. So on that basis if you are in an uptrend, and the price has previously bounced of the trend line. There is a probability that it will bounce off that line again.

So the logical place to enter a trade based on a trend is at the trend line, as you can use a tighter stop loss, so your risk reward is greater trading this way. You are entering a long trade, at the logical place, (the trend line). And you would place your stop loss just below the trend line, so if the trend line does not hold, and the price breaks through the trend line to the downside, your tight stop loss will limit your risk.

Depending on what time frame you are trading your stop loss could be as little as 5 pips trading this way. And if the price does bounce off the trend line, and continues its uptrend taking out the previous high (3) your potential risk reward is very good indeed.

When trend trading you need to be aware that the longer a trend continues up or down the more likely it is to reverse. You may get 3 or 4 or 5 or more swing highs, but with each swing high the likely hood of a reversal is greater, so entering a trade in the direction of the trend becomes more risky.

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