Back to basics – Trend Following and Channel Breakouts

Trend Following – and a specific system well-defined

trend following channel breakout

“Trend is your friend” and trend following systems provide an edge, and forex is the right market to trade the trend following systems because it often trends… lots of good books and pro trades say this.

OK, great, but many people including myself ask: “Fantastic, sounds good, I buy it, but how?”  How exactly to trade? How do I do “trend following”?

Read on for my take on the channel breakout system, as defined by Courtney Smith in his book called: “How to Make a Living Trading Foreign Exchange: A Guaranteed Income for Life“.

It offers a specific, almost mechanical set of rules to trade forex, in a trend following method, on an end of day basis.

The system, in a nutshell… Channel Breakout: it is to place a buy stop above the last 55-days high. Stop loss at the last bar. Exit if the price does not close above the channel for the first two days, exit if ADX turns down from 40, and trail the stop to last 20 days low. Reverse the rules for short. You can also use a multi-unit tactic and exit half of the trade, for profit at around 1R, i.e. a distance of the initial stop.

ADX shows a strength of a trend. If it is above 35-40, it means trend is very strong, if it then turns down, it indicates a trend may soon reverse or at least correct.

Buying the break of 55 high ensures we will participate in a big trend, if there is a big trend. Last bar stop and a rejection rule make our losses small. Trailing the stop lets the profits run and not exit on a noise, while exiting on ADX turn down often let’s us exit close to the top.

Lastly, there is an ADX filter: the buy stop order should be in place only if the ADX is raising, i.e. the trend is gaining strength. Buy stop order needs to look at Ask price, sell top at Bid, of course.

For buy stop and sell stop orders, we add 3 pips for majors and 5 pips for crosses to avoid some false breaks. See below how to try to profit from some false breaks.

We can trade a “ride the rejection rule” setup, from the Courtney book. If the price fails to close above the breakout channel level for the first two days, we exit at market on close and reverse the position, and close it on the following day, hopefully at profit, while the stop loss on this setup is above last bar high.

For a full description of the system, please get the book. I am not selling it, this is not an affiliate link, I just recommend it.

I believe it is a good approach to forex trading and am starting to test it now, you can follow it in this journal on forex factory.