How To Identify Forex Trends

Trends are a key concept to get to grips with when undertaking any form of financial trading and the Forex markets are no exception.

The ability to identify trends by the use of technical analysis is a key concept that you will need to become familiar with when trading Forex. They provide one of the most reliable indicators of future market direction and offer good opportunties to profit from. They are defined simply, as the direction in which a currency pair has been moving for an extended period of time.

An often used expression among Forex traders is 'let the trend be your friend'. This references the fact that Forex trends, once established, are more likely to continue than reverse.

Forex trends can exist across multiple chart timeframe's and can occur on any currency pair. They are most commonly classified in one of three ways:

Uptrend – In an uptrend an a currency pair will rally, often with intermediate periods of consolidation or minor movements against the trend. However the dominant direction of movement will be 'up'.

The currency pair will show a series of Higher Highs (HH's) and Higher Lows (HL's) on the chart.

Downtrend – In a downtrend an asset declines, often with intermediate periods of consolidation or minor movements against the trend. In a downtrend the dominant directional movement will be 'down.'

In this instance the pair will show a series of Lower Lows (LL's) and Lower Highs (LH's) on the chart.

Non-Trending - Here the value of a currency pair will often swing back and forth for long periods between defined upper and lower limits. There will be no apparent directional movement of the price (HH's & HL's or LL's & LH's). This is sometimes referred to as ‘sideways’ or ‘range bound’ movement.

Take a look at the AUD/USD Daily chart above. Simply by looking at the chart we can see visually that the pair is in an uptrend. The presence of this uptrend is further confirmed by the price action making a succession of higher highs (green) and higher lows (red) on the chart as the trend advances upwards.

A common way to profit from these market trends would be to enter a position when there is a pullback to a support level within the trend. At this point a trader could enter a long position (buy) in the direction of the major trend. In the above example, this would mean entering long at the higher lows shown in red on the chart. This technique is called “buying on dips”. A stop-loss for the trade would be placed below the lowest point that the price had traded in each pullback.

The opposite approach could be used for a market in a downtrend. The downtrend is identified when the pair has been displaying lower highs (green) and lower lows (red) on the chart..

In the example of the USDJPY below, you would wait for a pullback to a level of resistance (green) and then take a short position in the direction of the trend. Here a stop would be placed above the highest point to which the pair traded in the pullback. This approach is referred to as “selling on market rallies”.

The key point to note from this lesson is that by trading in the direction of the dominant trend, you are being backed by the greater momentum of the market and so in a sense, end up lowering the risk attached to your positions.

It is of course possible to identify trades against the trend. However profits earned in this way will come with a much greater level of risk attached. This is because you are effectively buying against the dominant direction of the market and therefore are in danger of the dominant trend resuming and taking out your position.

Trends in the currency markets will often continue for long periods of time. They can can last for days, weeks, months or even years. A longer term monthly trend may contain several shorter term daily or weekly trends within it. As with Support and Resistance levels that we look at next, a general rule of thumb is the longer the timeframe that the trend exists in, the stronger the trend will be.

Being able to spot trends in Forex is a vital part of identifying profitable opportunities to trade. Even short term traders need to be aware of trends when trading.

Make sure that you check for for established trends on your chart before trading. When shorter time frame trends start to break down , those running on higher timeframe's, such as weekly, monthly or even over a number of years are likely to persist.

Next: Support and Resistance levels