Advantages & Disadvantages Of Trend Following

Most successful forex investors or traders fall into a group called “trend followers.” Before going into the advantages & disadvantages of trend following, let us understand the term “trend following”.

Break down the term “trend following” into its components. The first part is “trend” and every trader needs to follow a trend to make money. No matter what the technique, there must be a trend up after you buy in order to sell at higher prices, in order to make profits. Traders always wait for the trend to move first, and then “follow” it, which is the next component of the term “trend following”. If the forex market is going in a down direction and then indicating a shift to the upside, the trend follower immediately buys that market. And while doing so, he is following the trend.

The trader uses various charts or mathematical representations of the market to measure the market direction. Once in a trend, the trader sits back land enjoys the ride, as long as the trend keeps going in the trader’s direction, allowing him to make profits. But unfortunately, the trend has to end at some point. So when the market direction shifts, then the trader has to “cut his losses short”, as the market is now moving against his position. Let us now take a look at the advantages and disadvantages of trend following.

The Advantages of Trend Following

One of the main advantages of trend following is that one will never miss a major move of any market. If the market you are following starts an upward direction, turning from a down, then it is a “buy” signal for the trader. A definite advantage of trend following is that the longer term trend-following indicators have lower transaction costs. If the investor realizes strategically that he can get onboard a major move in almost any forex market, then he can make substantial profits from just one trade. Even if the reliability of one’s strategy is far below 50 percent, one can still make a profit as the average size of one’s winning trades is so much greater than the size of one’s losing trades.

The Disadvantages of Trend Following

One main disadvantage of trend following is that any indicator is unable to detect whether the profitable move of the market is a short lived one or a major. So quite often, trend followers often get caught as trend-following signals immediately turn against them, thus causing small losses. These multiple small losses can add up and tempt the trend follower to abandon the strategy. Most forex markets have a large amount of time in non trending conditions.

Trending periods could make as little as 15 to 25 percent of the total time. Yet a trend follower should have the will to trade in these unfavorable markets so as to not to miss the big trend. Trend Following: advantages and disadvantages discussed in this article will give you right picture to make the right decisions while following trends.

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