Identifying trends in forex
Trends are the most important aspect when it comes to analyzing the financial markets. One of the key things, regardless of the kind of technical analysis is the trend. Therefore, it is important for traders to have a thorough understanding of the trend.
The trends in the financial market were first postulated by Charles Dow. Known as the father of the trend, Charles Dow was the first to identify the different types of trends in the market. According to Dow, known as the Dow Theory there are three major trends in the market.
- The primary trend is said to last over a few years.
- The secondary trend lasts over a few months.
- The minor trend lasts from a few days to a few weeks.
No matter what market you look at, you can be almost sure to find these three types of trends.
But the question that comes to mind is how to identify a trend. The answer to this comes from understanding the two trend types.
Types of trends
A trend can be primarily classified into a bullish or a bearish trend.
A bullish trend is where prices tend to move higher at a steady pace. In a bullish trend, you can see prices posting a higher high and a higher low. In a bullish trend, the common logic dictates that you buy into the rising trend.
A bearish trend is where prices tend to move lower at a steady pace. In a bearish trend, you can see price posting a lower high and a lower low. In a bearish trend, the logic dictates that you sell into the falling trend.
There are many ways to identify the trend. For one, you could use price action-based techniques such as trend lines or higher (and lower) support and resistance levels. Alternately, you could use indicators such as the moving averages to identify the trend.
The reason why trends are important is because this is the general assumption of the market at large. There are counter-trend strategies that go against the majority consensus. However, such strategies can be risky unless the trader is very confident of their analysis.
One of the favorite things that traders do is attempt to identify a trend in its early stages. This can be disastrous in a way. Trying to go against the trend near the top or trying to catch a bottom amid falling prices can prove to be fatal.
An important thing to bear in mind is that no one can predict a trend. A trend is identified mostly after it has been established.
How to identify a trend?
As mentioned earlier, there are two ways to identify a trend. You can use trend lines or simply make use of a trend indicator such as a moving average.
When using a moving average, the general conception is to use a 200-period simple moving average on a daily chart. When price is above its 200-period moving average, it is considered to be an uptrend. Likewise, when price is below its 200-period moving average, it is considered to be in a downtrend.
However, a general rule is that a market is considered to be in a bear market when prices drop 20% or more from the peak. The chart below shows a moving average with the trends.
Trends with moving averages
Besides the moving average, you can also use a trend line to plot the trends. Trend lines are of two types.
A rising trend is line is when you connect the higher lows in price. As long as price is above the rising trend line, it is a bull market. When price breaks the rising trend line the markets can be either flat or bearish.
A falling trend line is the opposite. This is drawn by connecting the lower highs in price. When price is below the falling trend line, it is a bear market. When price breaks the falling trend line, the markets can turn either flat or bullish.
The next chart below illustrates trends with trend lines.
Price trends with trend lines
You can see from the above two charts that the trend is almost the same, it’s the approach to identifying the trends that differs.
An important thing to note is that trends don’t change from bullish to bearish or vice versa. Between trends, there are times when price of an asset can turn flat. This can be seen in the above two charts. The periods between the bullish and the bearish trend is a period when prices are flat.
What can trends tell you about the price of an asset?
A trend can reveal valuable information. When you combine the three stages of trends, you will be able to time your pick for a trade.
In the forex markets, you can distinguish the trends between monthly, daily and intraday chart (H4). When you apply the Dow Theory of trends, you can then pick a shorter-term trend on the smaller time frame and trade in the direction of the main trend.
As a thumb rule, one of the safest ways to trade is to trade in the direction of the trend. There are many trend-based trading strategies that a trader can employ in order to trade in the direction of the general consensus.