Trading in the direction of the trend is something that is constantly mentioned in trading…and for good reason. A trader should trade in the direction that the market is taking the pair, NOT in the direction that they think the pair should be going. When this practice is adopted, the trader will find themselves entering into higher probability trades and increasing their chances of having a winning trade.
So, if trading in the direction of the trend leads to a greater chance of success, trading the strongest trends would be even better. This article will cover how to go about identifying the strongest trends so that concept can be coupled with the “room to move” principle in Part I.
Step one for me in determining the strongest trends is something that I do each and every trading day: the Strong/Weak currency analysis. (Rather than rewrite how to go about doing it in this article, this link will take you to a detailed description of the process in a previous article.)
For the purpose of this article, suffice it to say that after you have done the above S/W analysis, you will have a list before you of the strongest and weakest currencies at that moment in time. To zero in on the strongest trends, I pair up the strongest currency against the weakest currency and then take a look at the daily chart of that pair.
When I did the Strong/Weak analysis earlier, the GBP was the strongest currency and the JPY was the weakest. So let’s take a look at the Daily chart of the GBPJPY pair…
As we look at this chart we can definitely see the strong trend to the upside. The pair has been making higher highs (green lines) and higher lows (red lines) for a little over two months. Price action is above the 200 Simple Moving Average and is pulling away from it…more confirmation of a strong uptrend.
So based on this array of evidence that the GBPJPY is in a strong uptrend, this is the pair that I would be most interested in monitoring for a buy. The trade could be entered either when/if momentum shifts back to the upside or when/if price takes out the previous high. (How to enter a trade using either of these strategies can be found at this link.)
Regarding the room to move aspect of this trade, if the pair takes out the previous high in its most recent move to the upside, it has the room to move, potentially, about 170 pips to the next level of resistance on this daily chart.
If we were trading a pair that is in a strong daily downtrend, we would simply be looking for the opposite of the above…lower highs and lower lows and price action below the 200 SMA and pulling away from it.
Bottom Line: Trading the strongest trending pairs in the direction of the trend and determining that they have enough room to move to the designated profit target can result in higher probability trading.