Trend following for currency pairs

Market Environments

Markets generally follow a few distinct patterns. They are either trading within a specific trading range, or they are trending. A trending market is one in which a security moves in a generally direction and continues to perpetuate that movement over a specific period of time. Most markets trade in ranges for 70% of the time and only trend approximately 30% of the time.

Finding Trending Markets

One of the best tools to use to analyze a market environment and determine if the market is trending is the moving average. A moving average is an average in which each new data points replace the oldest data point to create a new average. For example, a 20-day moving average would sum the points of the last 20-days and divide by 20. On the 21st day, the average would drop the first day, and repeat the average calculation.

EURUSD Trend in Forex Market

In the chart of Lowes Companies, there are three moving averages which represent significant points for market participants. The 20-day moving average represents one monthly reporting period, while the 50-day moving average is closer to a quarterly reporting period. The 200-day moving average is actively used by financial institutions as it reflects approximately 75% of the entire year reporting period.

Moving Average Strategy

One of the most broadly used trading strategies that use moving averages to evaluate trends is the moving average crossover strategy. This strategy examines trends by looking for points in which a shorter term moving average (such as the 20-day moving average), crosses above a longer term moving average (such as the 50-day moving average)

Moving average Crossover

An example of a trade would be to purchase EUR/USD when the 20-day moving average crosses above the 50-day moving average, and to take profit either when the 20-day moving average crosses below the 50-day moving average or when prices fall below the 50-day moving average. Risk management techniques can range from a specific dollar amount, to a percentage, to a specific price level or moving average. If an investor purchased on the cross above and sold on the cross below they would generate 2-big figures of profit (1.25 purchases in August, 1.27 sales in November).

The length of the moving average depends on the time horizon of the investor, and their risk reward profile. A shorter term moving average crossover, such as the 5-day / 20-day moving average crossover, will produce many more signal when compared to longer term moving averages.

5-day / 20-day moving average crossover

Moving averages are lagging indicators, which mean that the trend is already in place when the crossover occurs. A shorter term moving average crossover can produce signals which will be short lived and require an investor to quickly reverse their position. In the example of Visa Inc., the buy signal in September would have produced $10 ($127 to $137), if profit where taken when the 5-day moving averages crossed below the 20-day moving average. The sell signal, which occurred during the crossover in late October, would have created a quick loss (selling at $138 and repurchasing at $138.50), if a stop loss was taken when the 5-day moving average crossed above the 20-day moving average.

Death cross / Golden Cross

Two of the most well-known moving average crossovers are the golden cross and the death cross. When the 50-day moving average crosses above the 200-day moving average, a gold cross occurs, which has historically shown to experience follow through and trending security. When the 50-day moving average crosses below the 200-day moving average, the death cross occurs, this has historically been a relatively fair indicator of a down trend.

More articles you can find here: www.buzzinforex.com