Trend following

What is Trend following in forex and CFD trading

Trend following is a systematic trading strategy that seeks to capitalize on the directional momentum of an asset, buying assets that are rising and shorting those that are falling, without attempting to predict reversals. Trend following matters for real trading decisions because it allows a trader to capture large, sustained market movements over weeks or months, defining entry only after the trend is confirmed. The presence of a trend following signal is verified on a trading platform by observing the relative position of price versus a long-term moving average, such as the 50- or 200-period SMA, confirming the existence of a sustained momentum. To explore more essential trading concepts, delve into our comprehensive forex glossary.

Key facts about Trend following

Strategy Objective: To capture the largest possible segment of a long-duration directional move, minimizing the impact of short-term volatility.

Core Signal: The momentum crossover of two moving averages, such as the 50-period SMA crossing above the 200-period SMA for a long signal.

Risk Management: Relies on wide stop-losses or trailing stops to manage risk, accepting numerous small losses in exchange for capturing large, infrequent wins.

Optimal Market: Best performed in markets exhibiting sustained, clear directional movement, often driven by significant shifts in economic or monetary policy.

Holding Period: Trades are typically held for several weeks to several months, making swap costs a secondary but monitored factor.

Typical Win Rate: Often low, ranging from 30% to 45%, but offset by a high Reward-to-Risk Ratio (R:R), often 1:3 or higher.

Formula for MA Crossover: Buy Signal: MAshort > MAlong, where MAshort is the faster moving average (e.g., 50 period) and MAlong is the slower moving average (e.g., 200 period).

How Trend following works in forex and CFD trading

The operation of a Trend following system is mechanical, relying on pre-defined criteria to enter and exit trades, reducing subjective decision-making.

The process involves these sequential steps:

1. Define the Trend: The trader applies two Moving Averages (MA), typically 50 and 200 periods, to a daily (D1) or 4-hour (H4) chart to establish the long-term direction.
2. Generate Entry Signal: A long entry is triggered only when the shorter MA crosses above the longer MA, and the price is above both (confirming an uptrend).
3. Execute Position: A market order is executed to open the position, following the confirmed trend direction.
4. Set Initial Stop-Loss: A wide, technical stop-loss is placed, often below a recent swing low or the 200-period MA, reflecting the strategy’s tolerance for noise.
5. Trail the Stop: As the price moves favorably, the initial stop-loss is replaced by a trailing stop based on a fixed percentage or a technical indicator like the Average True Range (ATR).
6. Exit Strategy: The trade remains open until the price action triggers the trailing stop, or the MAs cross back in the opposite direction, signaling a trend reversal.

Example of Trend following with a real trade

This example illustrates a Trend following trade on EUR/USD, capturing a large movement over two months.

Instrument: EUR/USD
Long Entry Signal: 50-day MA crosses above 200-day MA
Entry Price: 1.09500
Initial Stop-Loss: 1.08500 (Risk 100 pips)
Exit Price (Trailing Stop): 1.13500 (Closed after 60 days)
Position size: 0.5 standard lots (50,000 units)
Pip Gain: 1.13500 – 1.09500 = 400 pips

PnL Calculation:

Gross Profit (Pip Value): 400 pips × $5.00/pip = $2,000.00
Spread Cost: 0.2 pips × $5.00/pip = $1.00
Commission: $0.00 (zero commission structure)
Swap Cost: $50.00 net negative swap (over 60 days)
Total Costs: $1.00 + $0.00 + $50.00 = $51.00
Net PnL: $2,000.00 – $51.00 = $1,949.00

Result: $1,949.00 net profit. The zero commission structure is particularly advantageous for Trend following strategies, as it eliminates per-trade commission fees on both entry and exit—allowing traders to hold positions for extended periods (weeks or months) without commission costs compounding with swap fees. The large 400-pip profit target ensures that minimal spread costs and swap fees do not significantly detract from the return.

How Trend following affects your cost and risk

In Trend following, the primary risk is accepting a high ratio of small losses, requiring strict control over the risk-per-trade, while the cost impact of spreads is minimized due to the large target gains.

Trend following compared with related concepts

Trend following vs Scalping

Trend following is a low-frequency, systematic approach that accepts large drawdowns to capture multi-hundred-pip gains over weeks or months, utilizing wide stops and trailing stops. Scalping is a very high-frequency discretionary or automated strategy that seeks to capture tiny gains (e.g., 1 to 5 pips) in seconds or minutes, requiring ultra-low latency and near-zero spreads. Trend following is far less sensitive to transaction costs.

Trend following vs Breakout trading

Trend following systems typically confirm a trend only after a price breakout has already occurred, waiting for the moving averages to confirm the momentum before entry. Breakout trading aims to enter the trade precisely as the price penetrates a key resistance or support level, often using pending orders, aiming for immediate directional movement. Trend following enters later but with a higher confidence in the trend’s continuation.

Broker differences in Trend following across the industry

Differences among brokers affect Trend following mainly in capital efficiency and data integrity over long time horizons.

How to verify Trend following on your trading platform

Verifying a Trend following setup requires applying moving averages and confirming the momentum signal on a higher timeframe.

1. Select the Timeframe: Open a D1 (Daily) chart on a major pair like GBP/USD or a major index.
2. Apply MAs: Insert two Simple Moving Average (SMA) indicators: one set to 50 periods and one set to 200 periods.
3. Identify Crossover: Look for a sustained crossover: the 50-SMA crossing either above (for a bullish trend) or below (for a bearish trend) the 200-SMA.
4. Confirm Price Location: Verify that the current price candles are consistently closing above both MAs (for a long trend) or below both MAs (for a short trend).
5. Check Indicator Confirmation: Add a third momentum indicator, like the Average Directional Index (ADX), ensuring the ADX line is above 25, confirming strong trend strength.
6. Set Trailing Stop: When entering a trade, use the platform’s Order Ticket to set a Trailing Stop based on a fixed pip distance or percentage, ensuring automated risk management.
7. Sanity check: A valid Trend following entry must show the price, the short MA, and the long MA neatly stacked in order (e.g., Price > 50-MA > 200-MA for a long trend).