How To Identify Trading Trends in Forex Market

Last Updated September 7th 2021
7 Min Read

The forex market is the most traded global financial market. In this, participants can exchange a country’s currency for another currency. You can trade actively in this market for 24 hours a day for seven days a week across multiple time zones. Investors trade for a currency pair that keeps on fluctuating based on the market’s sentiments. When there is movement in the exchange rate, the trader makes or losses money. These movements, also known as trends, are essential for traders to make money. 

Investors use various techniques and indicators to identify these trends. Before getting into those details, first, let’s understand what is a trend?

What Is A Trend?

A trend in the forex market indicates the movement of the price of a currency pair in a predictable direction over a specific period. The price of a currency pair is known as the exchange rate. To increase your trading performance, you must understand the direction of this price movement. 

Trends can be of three types:

  • Upward or Bullish trend: In an upwards trend, you will notice a continuous sequence of rising highs and lows. Each subsequent high and low will be above that of previous ones.
  • Downward or Bearish trend: In this, there is a continuous fall of highs and lows. Each subsequent high and low will be below the last one. 
  • Horizontal or flat trend: In this, the price moves without any clear upwards and downwards movement. Most of the time, highs are arranged chaotically and are almost at the same level. On the other hand, low lies as a sleeping or horizontal line with no clear message or logic behind it.

Why Are Trends Important?

Trends help you pick the right path or direction. Identifying and understanding trends help you to trade in their direction rather than against them. If you trade in the direction of the trend, it increases your chances of success. When you know the trend, you can avoid any wrong buy or sell signs.

However, you must know that real-world trends defined above are not 100% accurate. It is not necessary that in an upward trend, the next high will be high. It can be below the last high as well. These are exceptions and you cannot avoid them as reality is different from theory. In the real world, you must consider a trend to be true that fits its definition the most.

Simple strategy of using trends for trading:

  • Buy orders when there is an upward trend
  • Sell orders when there is a downward trend
  • If the trend is not clearly defined, refrain from trading. On the other hand, if there is a clear sideways line, it’s better to sell in upper and buy in lower zones.

Though trends tend to deviate from their direction, they help you to determine which way to move for a more profitable trade. Several factors trigger a trend such as a change in a government policy, international transactions, supply and demand, and speculation and expectation.

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Identifying The Trading Trends

As a trader, you can identify the trend through technical analysis. This analysis includes both trend lines and indicators

Line graph

Most traders look for bars and candles to read a chart. However, a more effective and simpler tool is the line graph. Unlike bars and candles that give you detail information about the charts, a line graph can simply and quickly help you identify the trend direction. This is the perfect start for you to start identifying a trading trend.

Highs and lows

Spotting highs and lows on charts is also a very easy method to identify a trend. An uptrend here means a chart with higher highs and higher lows. This is because there are more buyers and pushes the price higher and lows are also high because buyers keep on buying dips sooner and sooner. On the other hand, a bearish or downtrend refers to lower highs and lower lows as a higher number of sellers move price in a lower direction and lows are also low because sellers are selling but there are no interested buyers in the market.

This method of identifying trends does not need any indicators. It is quite straightforward and purely a price action method. Though it is quite easy to understand, this is not the best method to spot trends.

Trendlines

This is another good method of identifying trends and will help you understand the market movements. Trendlines are suitable for later trend stages as you need at least 2-3 touchpoints to draw a trendline.

Trendlines are good if you want to identify an established trend. If you have a strong trend and the trendline breaks all of a sudden, it indicates a transition into a new trend.

A trendline is mainly a straight line that connects lows of an upward trend or highs on a downward trend. These lines work as support and resistance lines. 

With trendlines, there is a simple rule for actions:

  • Buy order in an uptrend, if the price tests the support line and reverses towards the trend.
  • Sell order in the downtrend, if the price tests the resistance levels and reverses toward trend. 

Identifying Trends With Indicators:

ADX

This indicates the average movement direction. This indicator helps in identifying a trend, and also the best time to make a trade. For any currency pair this indicator has three lines:

  • Positive directional indicator +DI
  • Negative direction indicator -DI
  • The ADX itself.

When the positive directional indicator moves above the negative indicator, it shows an uptrend. On the other hand, when a negative signal rises above a positive signal, it indicates a downtrend. In an uptrend, you can buy, and in a downtrend, you can sell.

However, both these signals make sense only if the ADX indicator is rising. If ADX is falling, you must think of profit-taking.

Read Also: Support And Resistance Analysis

Moving Average

This is the simplest and the most used indicator. It indicates the average price value over a particular period. In this, you can take the closing price of the last and most distant candlesticks with different statistical weights. Based on this, the moving average can be several types namely simple, smoothed, weighted, and exponential.

You can see moving average like support or resistance but as curves moving in time. Traders use different strategies to trade with moving average but the common approach is:

  • Buy a trade in an uptrend if the price hits the average from above and move towards the trend.
  • Sell a trade in a downtrend if the price hits the moving average from below and keeps moving towards the trend.

Based on this strategy, there are several indicators of moving averages. Some of them are:

MCAD (Moving Average Convergence and Divergence): This is the broadly used trend indicator as it is very simple and gives clear signals of the trader’s entry points. These indicators help you to identify the strength of the trend, the direction of the trend, and the possible reversal points.

This is mainly a momentum oscillator that is used to trade trends. On the chart, you can see this as two lines that oscillate without boundaries. The crossover of these lines gives you trading signals.

In this, you identify a trend by studying a 200-day moving average. For this, apply a 200-day moving average to the price chart to understand if prices are moving consistently above the average range. Now, once you know that price is moving above average, you can move to the second step of determining trade entry points in the chart. 

You can enter a long position wherever you observe an MCAD crossover with the bullish line above the bearish line (bullish crossover).

When you have entered an uptrend, you must also know where it can come to an end. If there is a bearish cross-over, it indicates that the momentum of the trend is decreasing and it can change its direction. If you are trading on a long position, you can start looking for an exit point from this point. However, it can be a temporary pullback also.

Bollinger bands: This indicator is also displayed on the chart of a currency pair. It consists of a set of three curves based on moving averages. The volatility of a financial instrument decides the Bollinger channel boundaries. When there is no clear-cut trend, the price will deviate from the midline. However, when the trend gains strength, there will be more deviations. As a result, the channel boundaries will diverge.

An important feature of the Bollinger band is that for about 95% of the time, the price stays within the channel. After analysing the Bollinger bands:

  • You can buy in an uptrend if the price tests the middle line from above and is moving towards the trend.
  • You can sell in a downtrend if the price tests the midline from below and is moving towards the trend.

Envelopes: Envelopes are based on two moving averages; one is upwards and the other is downwards. If the market has high volatility, the distance between these lines will be higher as well.

It means that both lines will make a channel and the price will mostly stay in this channel. Using this strategy you can:

  • Buy an order if the price nears the lower line in an uptrend
  • Sell an order if the price nears the upper line in a downtrend

Check Out: Why Should Traders Read Analysis Reports?

Conclusion

You can make the most of your trade following the trends. Thus, the tools and indicators that help you identify trading trends with high accuracy are important. Trading with a trend reduces the risk. So, don’t ignore the trends.

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