I would like to invite you to a special journey in the chart and in-between candlesticks. I promise I will do my best to make the ride enjoyable. I will discuss a discretionary forex trend following strategy to swing trade in a professional well-informed way. But wait, before you jump into the ride, let me tell you that you need to be familiar of key technical analysis topics. Such as reversal candlestick patterns and other topics. I included links to the explanation for each topic within the content of this post.
If you are new to trading forex, I strongly recommend you pass by our forex trading tutorials section.
Before I start explaining the strategy, let me explain what is swing trading and what is trend following.
What is Trend Following
Trend following is a type of trading where traders aim to catch the majority of a new trend. From near start to near finish. They aim to enter at the lowest price possible in an uptrend, and hold onto their trading position until sufficient evidence suggests that the trend may have reversed. Trend followers do not care about trading the pullbacks.
Most forex trend following strategies fail in a sideways high volatility market. If the same method in the above chart was applied to the below market conditions, it would have resulted in numerous false signals and whipsaws.
Trend Following Advantages
- Going with the price move.
- If trade signal was successful, trader would catch a major move.
- Excellent risk to reward ratio.
- Less time monitoring the market.
- Less number of trades equals less transaction cost.
Trend Following Disadvantages
- Trend following strategies work only if the market is moving in lengthy directional trend. And they usually lose money if the trend length is short.
- High volatility and fluctuations will result in whipsaws, false entries and exits.
- Stop loss is usually wide in a trend following trade. As the trader aims to account for unexpected pullbacks or to avoid getting stopped out before the actual trend starts.
What is Swing Trading
Swing trading is a type of trading where traders attempt to capture parts of the price up and down moves (swings) in the market.
Swing traders do not care about the underlying trend, as they would trade in the direction of the trend, or against it.
Typically, a swing trader would buy near support and sell near resistance.
Unlike trend followers, swing traders attempt to capture parts of the trend and trade sideways market. Therefore swing trades has a shorter time horizon.
Although that provides more trades, swing traders are likely to miss substantial price moves because of premature exit. Also more trades means more transaction cost.
Another drawback with swing trading is that traders will have to monitor and research the markets more.
But the primary drawback with swing trading is trading against the main underlying trend. Which is not recommended in most cases(Unless you have your own proprietary trading system, that you thoroughly tested and had consistent success rate).
Swing Trading Advantages
- Capture smaller trends.
- Can take advantage of high volatility sideways trends.
- Smaller stop loss.
Swing Trading Disadvantages
- Trading against the trend.
- Not that great risk to reward ratio
- More trades means higher transaction cost.
- More time monitoring the market
Combining Swing Trading and a Forex Trend Following Strategy
Using a mix of trend following and swing trading styles would provide the following advantages from both styles:
- Trading only in the direction of the trend.
- Staying in the trade a bit longer than using purely swing style, resulting in a better risk to reward.
- Capturing shorter trends.
- You will have more trades than a trend follower, and less trades than a swing trader.
What is Discretionary Trading
Unlike mechanical trading, which uses rules to initiate trades, discretionary trading is based on the judgment of the trader. A discretionary trader uses their experience and intuition to make trading decisions.
The main drawback of discretionary trading is the effect of emotions on a trader’s decision. However, intelligent traders would be able to develop objective methods to minimize this negative effect.
Strategy Overview
- Strategy style: Discretionary swing trend following strategy.
- Trading direction: Only in the direction of the identified trend.
- Time horizon: Short to medium term (Daily and 4-hour charts). Trades can last from one day to several weeks.
- Recommended period: 4-hour chart and above.
- Trend identification method: Trend structure identification
- Analysis tools: Reversal candlestick patterns, Horizontal support and resistance, Trend Lines, 200 and 50 days SMA, Chart patterns, Fibonacci retracements & extensions, 9-period Relative Strength Index(RSI), 14-period Average True Range .
- Breakout filter: Closing price.
- Target 1: 10 pips from the next major support or resistance.
- Target 2: Dynamic. whatever happens first from the following:
– If bearish signals outweigh bullish signals. Based my signal weight classification criteria(which I will explain shortly).
– At 5:1 risk reward ratio. - Stop loss: 0.5 the value of 14-period ATR below the nearest support or resistance (ATR explanation).
- Minimum average R/R for first target: 2 to 1 ( If first target does not satisfy this RR, we will discard the trade).
Signals Weight Classification
Giving different weight to technical signals will help you make better decisions. For instance, when you face two opposing technical signals, like a bearish overbought signal on RSI, and a bullish major candlestick pattern, you shouldn’t give both signals the same weight. The bullish hammer beats the bearish RSI.
Here is my classification for the technical signals:
Major signals:
- Trend direction.
- Chart patterns.
- Horizontal support in uptrend.
- Horizontal resistance in downtrend.
- Horizontal support and resistance breakout
- Long term moving averages as a support and resistance, or moving averages crossover
Intermediate signals:
- Candlestick patterns.
- Horizontal support in downtrend.
- Horizontal resistance in uptrend.
- Dynamic support and resistance(trend lines).
- 38.2, 50, 61.8 percent Fibonacci retracement levels as support and resistance.
- 1.271, 1.618 and 2.00 Fibonacci extension levels as support and resistance .
- Momentum signals in the direction of the trend.
Such as, overbought and oversold, bullish and bearish divergence. Momentum patterns and support/resistance break(momentum explained).
Minor signals:
- Trend line break.
- Small candlestick patterns.
- 23.6 and 78.6 percent Fibonacci retracement levels as support and resistance .
- Momentum signals against the direction of the trend.
Such as, bullish and bearish divergence. Momentum patterns and support/resistance.
Completely ignore signals:
- Momentum overbought signals in uptrends and oversold signals in downtrends.
Every 2 minor signals equates to one intermediate signal.
Every 2 intermediate signals equates to one major signal.
Every 4 minor signals equates to one major signal.
Chart Preparation
Step 1: Apply on daily chart: 200 and 50 days simple moving averages.
Step 2: Identify the mains swing highs and lows to identify the current trend structure.
Step 3: Identify and recent or present patterns.
In this case we had a gap. If below the price, the gap is a possible support level.
Stept 4: Draw the Fibonacci retracement from the latest swing high to the latest high.
Step 6: Draw trend lines. Connect lows to draw the lower trend lines. And connect the highs to draw the upper trend line.
Step 7: Add 14-period ATR and 9-period RSI. Draw RSI trend lines and support or resistance levels if any. (RSI explanation)
Step 8: Identify candlestick patterns.
Assessing the Technical Position
Major bullish signals:
- The price in an uptrends(higher highs and higher lows).
- The price broke out above the latest swing high
- The price broke the 200 days SMA.
Intermediate bullish signals:
- A shooting star candlestick high was broken to the upside signalling trend continuation.
- The price formed a gap on the breakout.
Major bearish signals: None
Intermediate bearish signals:
- The price formed a hanging man candle following the breakout
- The price is just below the dynamic resistance at the upper trend line.
A big win for the bullish scenario.
Bias: Bullish awaiting final confirmation.
Awaiting the Final Confirmation
Lets progress with the price action. We pressed the forward button to see how the price progresses. And what we had was:
- A bullish engulfing candle that broken the recent high and the upper trend line resistance.
- Broke the dragonfly doji high. And this is a bullish continuation signal as we explained in reversal candlestick patterns tutorial.
- RSI has also bounced of its rising trend line.
- And most importantly, all that happened in the context of an uptrend.
Add to that, the bullish breakout negated the only two intermediate bearish signals. As it broke the upper trend line and the hanging man high.
Bias : Bullish confirmed.
Initiating the Trend Following Trade
The trade: We decided to initiate a buy limit order just at the broken high price 1.0945.
- To find the next possible targets, we zoomed out to identify the next potential resistance levels (swing highs). The nearest resistance was at 1.1300.
- Therefore, we set our first target 10 pips below that resistance at 1.1290.
- Nearest support was at 1.0821. ATR reading was 75 pips. Therefore, our stop loss should be 37 pips below 1.0821 support at 1.0784. A perfect stop loss as it’s below the 200-days SMA and inside the gap. Both can form a support for any decline.
- The resulting RR was 2.14, above our minimum requirement of 2. The trade is valid and placed.
- We set the second target at 5:1 risk reward. The result price was at 1.1750, just above a long term potential resistance level at 1.1714. Therefore we adjusted the stop to 1.1700.
Fast forwarding: The price triggered our entry.
Fast forwarding: oops, bearish engulfing candle the next day, and RSI breaks its trend line. However, assessing the overall postives vs the negatives bias remains positive.
Reviewing the Technical Position
Major bullish signals:
- In Uptrend
- Still above horizontal support.
- Above 200 days SMA.
- Recent bullish breakout above resistance.
Intermediate bullish signals: None.
Minor bullish signals:
- Bullish breakout above rising upper trend line resistance.
Major bearish signals: None
Intermediate bearish signals:
- Bearish engulfing candlestick pattern.
Minor bearish signals:
- Bearish divergence on RSI.
- RSI breaks its trend line.
The bullish signals still significantly outweigh the bearish signals. We hold onto our trend following long trade.
Fast forwarding: As the price draws another bearish candle. We have now a new swing high that we can draw Fibonacci retracement on.
We drew Fibonacci retracement starting from the latest main swing low for the up wave, to the latest swing high.
Fast forward: Moving two days in time, we noticed the price has drawn multiple slightly long-legged doji candles at the 38.2% Fibonacci retracement level. That indicates slow down in the selling speed and more of indecision at this possible support.
We are still in red territory, but as long as we are sticking to our trading strategy, we shouldn’t care if we get stopped out.
Fast forwarding: Some relief, as the price rebounds strongly breaking both dojis highs and forming a bullish engulfing candle.
Fast forwarding: The price extended to the upside, and reached very close to our target. Then it entered a pullback without showing any major bearish reversal signs. On the contrary, the price formed a bullish hammer.
Fast forwarding: Finally, the price touched our first target. Then was rejected, forming a shooting star candle. However, as we explained in our candlestick patterns tutorial, what’s more important is the trend that led to the candlestick pattern, not the pattern it self. In this case, the pattern forms within a sideways range, with no clear up or down wave leading to it.
Note: we removed the second trade box for now for the chart clarity.
Reviewing the Technical Position
Fast forwards: We updated our chart for the latest price action. Outlined the latest swing low as support(hammer low). And adjusted the Fibonacci retracement tool to the latest high. And drew a new rising trend line.
Major positives:
- Trend remains up as latest swing low (suport) still intact.
- 50-days simple moving average crossed above the 200-days SMA.
Intermediate bullish:
- RSI is getting closer to oversold.
- Testing short term rising trend line support.
Minor Bullish:
- The price is at the 23.6 percent retracement.
Major Bearish: None.
Intermediate bearish:
- Testing horizontal resistance.
- Bearish shooting star candlestick pattern.
The bullish signals still significantly outweigh the bearish signals.
The price is approaching that support and the 23.6 percent retracement. Meanwhile, RSI is getting closer to oversold. We already know from the technical analysis basics tutorial that RSI overbought or near overbought signals when in an uptrend is a bullish signal. Therefore, we will monitor the price action on the daily and even on the lower time four-hour chart for a bullish confirmation signal to add to our long trade.
Awaiting the Final Confirmation
Fast forwarding: We had a small up candle on the daily chart above. But not enough to confirm a new trade. Let’s look at the four-hour chart.
The price has broken a very short term support level at 1.1166, before testing the main daily rising trend. A hammer candlestick pattern formed at the trend line, and the price rebounded to form a bullish engulfing, and settle back above 1.1166. Also, RSI is showing bullish divergence and touched overbought area.
A long trade is confirmed on the four-hour chart, but not the daily. That’s why we will only have one target. At the main resistance near the recent highs around 1.1300.
Initiating the Trend Following Trade
The trade: We decided to initiate a buy limit order just at 1.1166 level.
Stop loss = nearest support level – 0.5 (14-period ATR)
Nearest support is the low of the hammer at the rising trend line, however, another horizontal support at 1.1109 is very close. In such case, the stop should be put below the more major support that if broken will negate the whole idea behind the trade In this particular case 1.1109 is the more major support. The difference between the two support levels will be deducted from the distance we measure through the ATR.
ATR value was 28 pips.
The difference between support levels= 1.1132 – 1.1109= 23 pips.
Value of ATR – difference between support levels = 5 pips.
So stop loss will be 1.1109- half the value of ATR = 1.1109-2.5= round it to 1.1106.
However, because another key support is very close, we extended our stop to be below that support.
Finally, we will target the resistance at 1.1290, 10 pips below the next main resistance.
Fast forward: Price dropped to trigger our trade.
Fast forward: The price dropped close to our stop but bounced back higher. We noticed a bullish falling wedge pattern complete. Which is a positive signal for our trade.
Reviewing the Technical Position
Looking back the bigger picture on the daily chart. The rising trend line was broken. But according to our signal weight classification, a trend line break is a minor signal.
The positive still outweigh the negatives, and the trad remains valid.
Fast forwarding: Boom, strong rally and target hit.
Fast forwarding: Going back to the daily chart, the price extended the up move before pulling back towards the broken resistance, which may turn support now. Indeed the price formed long-legged doji.
Initiating an Additional Trend Following Trade
In this case we wanted to place a long trade. We always use the nearest support for our limit order. In this particular case, the nearest support is long legged doji candle. In such case, we place our order 10 pips above the low of the candle.
So it’s going to be at 1.1322, as the low of the candle at 1.1312.
As both the low of the candle and the next horizontal support are very near. We will use the same method we used in the prior trade. We will place the stop loss below the main support at 1.1300. But deduct the different between the two support level from the ATR value.
ATR = 69.
The difference between low of the candle and the support level is 12 pips. so the new ATR will be 69 – 12 = 57 pips.
0.5×57= 26 pips.
Our stop will be at 1.1300-26 = 1.1274
Our first target would be 10 pips below the next main potential resistance level, which is at the most recent swing high at 1.1445. So Stop = 1.1335.
The resulting RR for the first target is 2.35. Accepted.
Fast forwarding: The price rallied and reached the first target without triggering out buy limit order. In such case, the trade is no longer valid and we cancel it.
Let’s get back to our active trade now. The technical position remain unchanged. As there is no new bearish signals.
Fast forwarding: The price has extended the bullish trend, and reached our full target without showing any serious bearish signals.
Lets try to find a new signal. We updated the the chart with the most recent price action. Drew a rising trend line. And identified the latest swing highs and lows.
Fast forward: We moved in time until we saw this hammer candle. Which confirmed a new long trade.
The trade: buy limit at the nearest support. But since the hammer candle low is the support at 1.1689. We placed our entry limit order 10 pips above the hammer low. At 1.1699.
ATR reading was nearly 90 pips. So we placed our stop 45 pips below the low of the hammer at 1.1654.
First target 10 pips below next swing high resistance at 1.1900.
Resulting RR is 4.47. In this case, where should we place the second target, as we use 5:1 risk reward for it. so it will be very close to first target.
If the value of RR for the first target is more than 2.5. Double it for the second target.
The second target RR should be 4.47×2 = approximately 9.
Second target will be at 1.2105.
Fast forwarding: The price moved higher the next couple of sessions before reversing and triggering our buy entry.
Fast forwarding: Later on the price reached first target.
Note that the price is approaching a major long term potential resistance level.
Fast forwarding: The price hit that resistance and formed a major gravestone doji candle.
Reviewing the Technical Position
We have to review the technical position as the price presented new bearish signals.
Major positives:
- Trend remains up as latest swing low (suport) still intact.
Intermediate bullish: None.
Minor Bullish: None
Major Bearish: None.
Intermediate bearish:
- Testing horizontal resistance.
- Bearish Dragonfly candlestick pattern.
Minor Bearish:
- RSI showing bearish divergence
One major bullish signal versus two intermediate and one minor bearish signals. As every two intermediate equates to one major signal, what remains is a bearish minor signal.
Therefore, we decided to close the remaining of our position at market price. Which is still above the first target.
Conclusion
I end the journey here and hope you enjoyed it. My main goal was to help you form your own framework trend following strategy when swing trading the forex market.
Ofcourse market conditions will result in profitable and losing trades. It was a coincidence that period provided a few winners. However, as long as you keep your approach unified and practice good money management, you should end up doing fine.
I am looking for your opinion and feedback or questions in the comments section. Trade with care.
Disclaimer: The content provided is for educational purposes only. The information presented must not be taken as investment strategy recommendation.
Looks interesting. Haven’t read it yet, but I went through it and liked the idea of combining a trend following strategy with swing trading. Thumbs up.
Glad to help.
Beautiful Tech. Thank you for the time and effort put in this trend following art.
You are welcome!
Good work , NIce sharing
Thank for yr effort to make great site.
You are most welcome 🙂
Very useful tutorial.
Thanks for sharing. Good strategy.
You are welcome :).
Thank you very much for sharing your knowledge and experience.
Thanks Karen, appreciate your comments.