How to Trade for Maximum Pip Gain

08/25/2011 6:00 am EST

Focus: FOREX

This USD/CHF example shows that trading with the dominant trend, rather than trading countertrend moves, would have allowed the trader to capture nearly 50% more pips.

In setting up a currency trading plan, we always advocate making one of your rules to take trades in the direction of the overall trend, as those will be the ones with the greater probability of success. That being said, there are two questions that are always asked: 1) “Why is that true?” and 2) “If that is true, is there really that much of a difference in the potential pips?”

While pips can be made trading countertrend, they will come with a greater amount of risk. Essentially, when taking trades in the direction of the trend, the trader has the momentum—the “push”—of the market behind them.

When trading countertrend, there is less momentum pushing in that direction and the dominant trend can kick back in at any time, negating some or all of the profits that may have been gained by trading against the trend.

Also, when a trader knows that they essentially have the market behind their trade when trading with the trend, they have more confidence to stick with the trade and let it mature, as opposed to closing out the trade too early.

Lastly, countertrend entries need to be much more precise since you are trying to time an entry while it is moving in the opposite direction. On the other hand, entries with the trend can be more forgiving.

Let’s take a more in depth look at this concept on a daily chart of the USD/CHF:

chart
Click to Enlarge

The approximate number of pips in each move to the downside (in the direction of the trend) is shown in green. The approximate number of pips in each move the upside (against the trend) is shown in red.

While we can definitely see that pips can be made trading countertrend (4,070 pips in this example), there is a significant difference in the number of pips earned by the trader who only took trades in the direction of the trend.

Based on this chart, trading with the trend would have accumulated 3,685 more pips, roughly 47% more than a trader who only took countertrend trades. You wouldn’t catch every pip in the direction of the trend, of course, but doesn’t it make sense to put the odds in your favor?

By Richard Krivo of DailyFX.com

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