SCOTT WELSH TRADING BLOG

The Best Currency Pair For Trend Following

The Best Currency Pair For Trend Following

Mar. 6, 2019

Finding the best instrument to trade is tricky.

What’s best for one trader is not necessarily best for another.

Yet we’re still drawn to the discussion.

There are a lot of layers to this topic, but I think we can determine which instruments are better than others.

This week we’re going to talk about trend following.

It’s arguably the greatest trading methodology ever invented, and it’s easy to understand.

Everyone can see that humans are emotional and trends exist. All we have to do is follow those trends and we’ll end up okay.

In fact, if you believe the research, trend followers will come out ahead of index funders by a nice margin.

That being said, there are two major forms of trend following.

The first is a simple moving average cross. When a fast moving average crosses a slow moving average, something is afoot. The prices today are rising or falling faster than they did weeks ago, so something clearly has changed in the market.

A moving average cross gives us a mathematical depiction of the obvious start of a trend.

And the most famous moving average cross is the Golden Cross (for Long trades). When the 50 SMA crosses above the 200 SMA, there is an upward trend developing.

Its evil doppelganger is the Death Cross (for Short trades). When the 50 SMA crosses below the 200 SMA, there is a downward trend developing.

The great thing about trading with this system is that we don’t need to optimize a thing. It’s been around so long (and tested so much) that we don’t need to do any further work.

If we use this system, we can get started right away.

The only thing we have to choose is the profit target, the stoploss, and if we want to move to break-even at any point. That could take some work, but we’re being lazy this week. We want something simple.

So we’ll put very little thought into it. We’ll just let this universal system do most of the work and stay out of it as much as we can. Here are the details:

  • System: The Golden Cross/Death Cross (Trend Following)
  • Philosophy Behind It: Trend following is eternal and this is one of the most famous ways to be a trend follower; we’ll go Long when short term prices are increasing and go Short when short-term prices start decreasing.
  • Need Special Indicators? No.
  • Chart: Daily
  • Instrument: Forex
  • Long or Short? Both
  • Long Entry: 1) The 50 SMA most close above the 200 SMA; 2) Enter at Open of next bar
  • Short Entry: 1) The 50 SMA most close below the 200 SMA; 2) Enter at Open of next bar
  • Stop Loss: 300 pips
  • Take Profit: 500 pips
  • Move to Break-Even?: Yes, after 100 pips of profit has been attained
  • Trade size: 1 lot
  • Hypothetical account size: $20,000
  • Test Period: 2003-2019
  • Number of Trades: about 1.3 trades per year on average

To find the best currency pair, we’ll use these same settings on everything. No optimizing. Whichever currency pair performs the best will be our choice.

In total, I tested 16 different pairs.

The winner?

It was a tie. Kind of.

The EURUSD, GBPUSD, and the NZDUSD all made the same amount of profit: $11,000. (Keep in mind that these hypothetical numbers do not use compounding. They had the same trade size for every trade.)

But they had different drawdowns.

The EURUSD and GBPUSD had drawdowns just over $10,000. The NZDUSD had a drawdown of about $7,800.

In that comparison, we might say that NZDUSD is the best. It tied for most profit and had less drawdown.

Not so fast.

There is another famous form of trend following: the Breakout. This form might actually be more famous (because of the Turtles).

As a reminder, here are those details:

  • System: The Breakout (Trend Following)
  • Philosophy Behind It: Trend following is eternal and this is one of the most famous ways to be a trend follower; we’ll go Long when price breaks above the high of the past 75 bars and go Short when price breaks below the low of the past 75 bars
  • Need Special Indicators? No.
  • Chart: Daily
  • Instrument: Forex
  • Long or Short? Both
  • Long Entry: 1) Price breaks above 75-bar high
  • Short Entry: 1) Price breaks below 75-bar low
  • Stop Loss: the amount of the ATR of the past 20 bars
  • Take Profit: Unlimited
  • Trailing Stop?: Yes, above or below the high or low of the past 10 bars
  • Trade size: Risk 5% of the account on each trade
  • Hypothetical account size: $20,000
  • Test Period: 2003-2019
  • Number of Trades: about 6 trades per year on average

Looking at the top 3 trend followers from our first test, we find something interesting.

The EURUSD had a profit (using compounding) of $222,292. The max drawdown came in at around 41% (less than the market over that time).

The other two (NZDUSD and GBPUSD) were both negative. They didn’t make a penny.

As you can see, when we combine the two famous trend following methods and do no optimizing, the EURUSD comes in first by a landslide. It works with a moving average cross and it works magnificently on breakouts. The other two only work in a Golden Cross environment.

So, if you want to trade Forex and want to use an eternal, trend following methodology, the data shows that you should start your journey by looking at the EURUSD.

In fact, the research shows that just the Breakout method alone would beat the market by a mile.

A trader would just have to be willing to compound gains and take a 40-50% drawdown at some point in the journey.

Talk to you soon.

 

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Disclaimer:
It should not be assumed that the methods, techniques, or indicators presented in these products will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these sites are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The authors, the publisher, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.

HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS MAY HAVE UNDER- OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.