Forex traders use a variety of tools to make trading decisions. While some of those tools or indicators can be complex, some are simple and can be used by even novice forex traders. One of the best ways to understand the forex market is to identify trading trends. What is a trading trend and how can one identify it? Read on for answers to these and many more questions about trading trends.
So, what is a forex trading trend?
In simple terms, a forex trend is the general direction in which the price of a given currency pair is moving. The price can, in general terms be described as going up (increasing) or going down (decreasing). Those two general tendencies give us the two trends known in forex trading.
The bullish trend
When the bulls (buyers) are in charge, the price of the currency will keep going up, broadly speaking. This is what is called a bullish trend. If you are viewing a candlestick chart, you will notice that the highest price during a given timeframe, such as 4 hours, will keep rising higher than the highest point of the previous trading periods in your analysis.
The bearish trend
When the bears (sellers) are the majority, we will have a bearish trend. This is because the price will drop as a result of too many people selling while buyers are in short supply. Again, a look at your chart will show you that the lowest price on the candlesticks depicting price action in the timeframe (4 hours, for example) you are looking at will generally keep getting lower for subsequent 4-hour periods.
Consolidating/choppy market
Note that even during a bullish or bearish trend, there will be moments in which the price seems to go nowhere. That is, the price will fluctuate within a narrow range. We call this a choppy market and many traders opt to stay out of the market during such price action.
It is also important to note that while a trend provides a general direction of the price during a given period, prices rarely move up or down all the time during the trend. Rather, the price can retrace in the opposite direction as buyers or sellers jostle to regain control of the forex market.
How to identify trading trends in forex trading
Price action
As already suggested in the discussion above, price action can give you a quick way to ascertain whether there is a bullish trend or a bearish trend.
Sticking with the example of candlestick charts, as shown in the example below, several consecutive candlesticks depicting higher highs together with higher lows denotes a bullish trend. Conversely, consecutive candlesticks depicting lower lows and lower highs points to a bear trend.
As you can see the red bars on the left, the market/price is going down. However, there seems to be a trend reversal when we look at the area circled and the green bars going up on the right.
Line graphs
While candlesticks are a popular method used to spot trends in price action, line graphs also offer a simple way to detect a trend in its early stages. In the example below, the blue lines show bull trends while the red lines show bear trends.
Moving average crossover
Another way to identify a developing trend is by using moving averages. The technical term for this indicator is MACD (moving average crossover and divergence). This technique relies on two lines showing the average price of a currency in question. One line tracks a shorter time frame, such as one day. The other tracks a longer timeframe, such as one week. The line shows the average price for five periods (such as five consecutive single-day trading).
As you may have guessed, the line for the longer timeframe will move more slowly than the line for the shorter trading period. A possible trend may be forming once the faster-moving line crosses the slower line in an upwards direction. In contrast, a bear trend may be brewing if the faster line faces downwards and crosses the line of the longer trading periods.
In the chart example above, we see the moving averages cross for a bullish trend in the zone having a green circle and the area with a red circle shows the point at which a bearish cross takes place.
Note that it is always wise to rely on more than one indicator before making a decision to enter the market as a result of noticing a developing or changing trend. This is because each technique, such as price action analysis, has its own strengths and drawbacks. For this reason, using more than one indicator to determine when a trend has formed or is changing will give you a more reliable signal upon which you can base your trading decision.
As you gain more experience as a trader, you will be introduced to many other ways to identify trends and make trading decisions. The key takeaway here is that you should make the trend your friend if you want to succeed as a forex trader. It is easier to swim with the tide rather than against it, remember!
Risk Warning
High-Risk Investment Warning: Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to trade foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial adviser if you have any doubts.
