How to trade on trends
HOW TO TRADE ON TRENDS
In forex trading, a trend is the propensity of a price to move in one direction or another over a period of time. A forex trend can last anything from a few weeks and months to 1 year and 5 years and longer.
There are three types of trends that occur in forex trading:
- Long-term/secular trend: lasts for 5 years and longer
- Intermediate/primary trend: lasts for 1 year or longer
- Shor-term/secondary trend: lasts for a few weeks to a few months
Price movements don’t only follow an up an down trend. You also get horizontal price movements. Commonly known as sideways trends, this is where the forces of supply and demand are nearly equal. A sideway price trend tends to hover there during a period of market consolidation before it reverts back to an earlier trend or moves towards a new trend.
Being able to correctly interpret trends to capitalise on trading opportunities is fundamental to trading forex. Trend traders hone their trading skills to identify trends and place buy or sell positions at the most profitable entry or exit points.
Trend trading versus range trading
Forex traders generally choose between two strategies to analyse historic market data and take positions on an underlying asset. These two are range trading and trend trading.
Range trading is the more common approach and suited for beginner forex traders. It involves determining a range between support and resistance levels and attempting to make a profit from both upward and downward short-term price movements that occur between those levels.
The main task of range trading is to find the range and this is done fairly easily by connecting a series of highs and lows with a horizontal trend line. You need to find two points to connect on your graph and once found, these values can be taken as the support and resistance levels. The area in between is your trading range.
Trend trading involves taking a longer approach to positions where traders take positions along a series of price movements in a particular direction. This would either be an upward or a downward direction.
Trend traders attempt to minimise losses that range traders experience from price breakouts in a given range. They do this by establishing positions that are likely to realise large price movements over a longer period of time.
The challenge of forex trend trading is to get in early on a position and hold it until the trend shows signs of reversing. Trend traders bank on the assumption that the price of a currency will continue in its present direction but if it doesn’t, then traders know that there’s no point on continuing to hold the trade.
Typically, trend traders trade using tight stops to manage the high risk of this type of forex trading. They also trade in highly liquid currency pairs so they can get in early and close early if the price direction moves against them.
Predicting or anticipating a trend
Forex trading is not a glamorous form of gambling as some people may think. Currency pairs are traded strategically following a disciplined trading strategy and using technical analysis to study historic price data.
Technical analysis allows trend traders to anticipate price movements and capitalise on trading opportunities based on the notion that ‘history tends to repeat itself’. Forex traders learn from how the market has performed in the past in a trend and bet on the probability that the forex market will deliver profits and losses along the same lines.
Contrary to popular belief, forex traders who trade on trends don’t try to predict the future. They follow trading strategies that have a high probability of succeeding. In other words, using technical analysis and even fundamental analysis, these traders anticipate price movement and points based on objective thinking.
If trend traders didn’t do this, it would be like them putting their tokens on red or black and hoping the white ball lands on the colour they chose.
Fundamental analysis also helps trend traders anticipate price movements. Typically, a country that has a strong and stable economy will also have a strong currency. It’s all about supply and demand. The more attractive a currency is, the more demand there will be for it.
How to identify a trend in the forex market
Trend traders use technical analysis to identify trends. In other words, they make extensive use of technical charts that map historic data on price movements.
Trends are marked on technical charts by a sequence of higher and lower trading ranges. An uptrend represents a series of higher highs and higher lows. A downtrend represents a series of lower highs and lower lows.
Trends picked up on the charts last anything from a few hours or days to week and months. It takes patience to wait out a trend and nerves of steel to trade on trends. At any time, trends can be reversed or suspended depending on underlying market conditions. Something like the Covid-19 pandemic would obliterate a trend.
Type of forex trends
There are three types of trends in forex trading: an uptrend, downtrend and sideways trend.
Uptrend (higher lows)
An uptrend is created by higher swing lows and higher swing highs. In other words, the overall direction of the price movement is upward. Each successive peak and trough in an uptrend is higher than the previous recorded peak and trough.
- The uptrend stays intact as long as the price continues to make higher swing lows and higher swing highs.
- An uptrend reverses and becomes and downtrend when the price starts making lower swing highs and lower swing lows.
The best way to identify an uptrend is to draw forex trend lines. You do this by identifying no less than two major price tops or bottoms and connect them.
Downtrend (lower highs)
A downtrend obviously works in contrast to an uptrend. With a downtrend, the price may fluctuate higher and lower at times but it is always going in a downward direction.
A downtrend is easy to recognise because it has lower peaks and lower troughs. Basically, a downtrend is an uptrend that has started to take strain and the upward direction reverses in incremental steps or fairly dramatically due to a major event.
Sideways trend (ranging)
When a trend is ranging, it is moving in a horizontal direction. This is known as a sideways trend when the forces of supply and demand are almost equal. Sideways trends occur for a period of time when the price hovers while the market consolidates, and then continues on an uptrend or downtrend.
A sideways trend can dominate for a long time, particularly when the currency price gets stuck between strong support and resistance levels. In a sideways trend, there is an equal balance between ‘bulls and bears’ and it will remain that way until either one shoots up or down when a breakout or breakdown occurs.
Using forex indicators to identify trends
The most popular way traders identify trends is making use of forex technical indicators. They are available on trading platforms such as MetaTrader 4 and are used to measure open prices, highs, lows, closing prices and volumes.
Some of the indicators available for technical analysis of trends are quite complicated. It’s best to stick to the two basic forex indicators if you are new to trading forex.
Simple Moving Average (SMA)
The simple moving average (SMA) is the average price of a currency over a specific period of time. For example, a 20-day moving average is the average (mean) of the closing prices over a period of 20 days. Forex traders prefer to look at the closing prices for analysis, rather than the opening prices.
SMA are useful because they flatten out fluctuations in the price movements to reveal a trend. In other words, is the price in an uptrend or downtrend. The longer the time period of the SMA, the more flattened the data will be and the slower it will react to changes in the market.
SMAs typically operate with averages calculated from more than one set of data. One or more set would be the SMA within a shorter period of time and one or more would be within a longer time period.
- Shorter SMAs are run anything from 10 to 20 days.
- Longer SMAs are run anything from 50 to 200 days.
SMAs signal a new trend when the long-term average crosses over the short-term average.
- When the long-term average moves above the short-term average, it signals to traders the beginning of an uptrend.
- When the long-term average moves below the short-term average, it signals to traders the beginning of a downtrend.
Exponential Moving Average (EMA)
An exponential moving average (EMA) is similar to a moving average but it focuses on more recent prices. This difference means EMAs respond more quickly to changes in price movements.
- Shorter EMAs are run anything from 12 to 26 days.
- Longer EMAs are run anything from 50 to 200 days.
A very simple EMA system is the dual moving average where you trade each time the two moving averages cross. With the dual moving average, traders always have a position, whether it’s long or short on the currency pair that is being traded.
- When the shorter moving average crosses above the slower moving average, a trader goes long (buys) on a position.
- When the shorter moving average crosses below the slower moving average, traders go short (sell) on a position.
Trend trading versus swing trading
Forex trading strategies typically fall into these two styles: trend trading or swing trading.
Basically, trend traders take a risk on the forex market in an uptrend or a downtrend; holding a position until the trend changes. Swing traders trade within a range, buying at support and selling at resistance levels.
Trend traders tend to hold a position in an uptrend or downtrend for a longer period of time, anything up to a few months or a year and more.
Swing traders hold positions for a shorter period of time and make more trades more frequently. While swing traders do take large positions on a trade, they have to be more precise with the timing of their position.
Real-time charting has made technical analysis for both trend and swing trading a lot easier. Swing trading works best in shorter time frames while trend trading usually involves longer timeframes that flatten out volatility in the market to reveal an uptrend or downtrend.
Real-time charting conveys information to traders at a speed that is almost instantaneous. Online retail brokers make extensive use of real-time charts in technical analysis because there is close to zero lag time. The information provided in the real-time charts provides the most up-to-date information on events that are happening in that moment.
Is it safe to trade forex on trends?
As the say in the forex market, the “trend is your friend”. That is, until the trend ends and is no longer your friend. Forex trading is associated with high risks and you risk losing your capital regardless of what trading style you adopt.
The best advise given to reduce your risk when trading on trends on the forex market is to keep it simple. Focus on one trading strategy – trend trading or swing trading – and hone your skills and ability to interpret technical data in that format.
Both trend and swing trading rely on market timing. This trading skill relies on investors or traders attempting to predict price movements and buying or selling at the right time. It’s the complete opposite to a ‘buy-and-hold” forex trading strategy.
The latter is a passive strategy where investors and traders buy an underlying asset and hold onto it for a long period of time, riding out market volatility until it’s time to close the position for a profit. Market timing takes experience and discipline to master and it’s recommended beginner traders use the free resource of a demo account to become accomplished in trend trading.
Forex Trading Africa Disclaimer
Trading forex is associated with high risks and can lead to investors and traders losing a significant amount of money. The information in this article should only be used to educate yourself on how forex trading works and the pros and cons of trading on the forex and stock markets.
Pay due caution to the risks involved in trend trading and take the necessary precautions to avoid losing capital on forex positions.