Trading Trend Or Range?

Whether trading stocks, futures, options or FX, traders confront the single most important question: to trade trend or range? And they answer this question by assessing the price environment; doing so accurately greatly enhances a trader's chance of success. Trend or range are two distinct price properties requiring almost diametrically opposed mindsets and money-management techniques. Fortunately, the FX market is uniquely suited to accommodate both styles, providing trend and range traders with opportunities for profit. Since trend trading is far more popular, let's first examine how trend traders can benefit from FX.


Trend
What is trend? The simplest identifiers of trend direction are higher lows in an uptrend and lower highs in a downtrend. Some define trend as a deviation from a range as indicated by Bollinger Band "bands" (see Using Bollinger Band "Bands" to Trade Trend in FX). For others, a trend occurs when prices are contained by an upward or downward sloping 20-period simple moving average (SMA).

Regardless of how one defines it, the goal of trend trading is the same - join the move early and hold the position until the trend reverses. The basic mindset of trend trader is "I am right or I am out?" The implied bet all trend traders make is that price will continue in its present direction. If it doesn't there is little reason to hold onto the trade. Therefore, trend traders typically trade with tight stops and often make many probative forays into the market in order to make the right entry.

By nature, trend trading generates far more losing trades than winning trades and requires rigorous risk control. The usual rule of thumb is that trend traders should never risk more than 1.5-2.5% of their capital on any given trade. On a 10,000-unit (10K) account trading 100K standard lots, that means stops as small as 15-25 pips behind the entry price. Clearly, in order to practice such a method, a trader must have confidence that the market traded will be highly liquid.

Of course the FX market is the most liquid market in the world. With US$1.6 trillion of average daily turnover, the currency market dwarfs the stock and bond markets in size. Furthermore, the FX market trades 24 hours a day five days a week, eliminating much of the gap risk found in exchange-based markets. Certainly gaps sometimes happen in FX, but not nearly as frequently as they occur in stock or bond markets, so slippage is far less of a problem.