Trends in Forex Explained for Dummies

What is a trend in trading?

In trading, a trend occurs when the price of an asset is moving in a particular direction (higher or lower) over a given period of time. Express differently, the formation of a trend takes place when the price of a security or an asset indicates:

• an uptrend pattern of higher highs and higher lows, or
• a downtrend sequence, comprising lower lows and lower highs.

Trends play an extremely important role in technical analysis, which is the study of historical price data in order to identify price patterns and predict future price movements. One of the assumptions of technical analysis is that the price of a security or currency will follow an established trend and pattern as it has done in the past. Martin Zweig (1942 - 2013), a famous American stock investor and financial analyst, who predicted the stock market crash in the USA in October 1987, coined the phrase, ‘The trend is your friend.’ The implication is that an existing trend is probably to continue and deserves one’s time and attention. In addition, as an influential investor, he gave the following advice: ‘The idea is to buy when the probability is greatest that the market is going to advance.’ (Accentuation by the article writer.) Trend trading refers to a trading style that aims to take profits by analysing the momentum of security, asset, or currency’s price in a particular direction (upward or downward). Trends occur in all types of financial markets, such as stocks (shares), futures, bonds, commodities, and forex.  

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What is a forex trend?

A forex trend indicates the rise or fall of a currency’s value, based on supply and demand. A currency’s price is in an upward trend when there is a high demand for a currency or a shortage in its supply. Contrarily, a downward trend in the price of a currency is caused by low demand for or an excess supply of the particular currency.  

Types of trends in forex

Basically, there are three types of trends in the forex market - as is the case in all financial markets.  

• Uptrend

An uptrend, commonly referred to as a bullish trend, comprises a series of higher highs (HH) and higher lows (HL). A trend is considered an uptrend if there is a definitive support line that connects at least two lows and limits the downward momentum.  

• Downtrend

A downtrend, commonly called a bearish trend, is described as a series of lower lows (LL) and lower highs (LH), indicating prices are decreasing. A downtrend can be identified if a clear resistance line connects at least two highs, restraining the upside.  

• Sideways trend

When prices zigzag sideways, not moving in a well-defined direction, it is called a sideways trend, also known as a horizontal trend or a flat trend. The zig zagging of a price is referred to as ranging.  

How long does a trend continue?

Regarding length, a trend belongs to one of the following categories:

• A short-term trend lasts less than a week. Minute and hourly charts are the most suitable to identify short-term trends.
• Medium-term trends can carry on for a week up to a couple of months. They can be followed on daily or H4 (4-hour daily time frame) charts.
• Long-term trends refer to major trends, lasting 6 months - 2.5 years. They can be traced on weekly or monthly charts. A long-term trend includes several medium-term and long-term trends, which often move in the opposite direction as the major trend.

 

Identifying forex trends

Market prices of currencies do not represent a straight line. Instead, the prices move up and down, forming peaks and troughs as trading continues. Trends develop by forming a sequence of peaks and troughs. By comparing the rising and falling troughs to each other as well as the rising and falling peaks to each other, a specific trend can be identified.

Methods used to identify trends in forex markets

The most common methods to identify forex trends are:

• Higher highs and higher lows/Lower highs and lower lows.
• Trend lines.

 

Higher highs and higher lows/Lower highs and lower lows

Bear in mind, there are no specific regulations or principles to identify highs and lows in the analysing of trends. The bottom line is to choose the most obvious price signals that represent an uptrend or downtrend.

• Higher highs and higher lows

  An uptrend is confirmed when a series of higher highs and higher lows appear on a trading chart of a particular currency pair - as indicated in the illustration above. Take note of how each high is subsequently followed by a higher high and how each low is higher than the previous low. Realistically, a specific trend does not continue forever. Hence, an uptrend will either:

• change into a sideways trend when the price of a currency starts to move in no definitive direction,
• change to a downtrend when a sequence of lower highs and lower lows is established.

 

• Lower highs and lower lows

A downtrend is formed when a succession of lower highs and lower lows emerges on a price chart of a currency pair - see illustration above. In a downward trend, each high is obviously followed by a lower high, and each low is succeeded by a lower low. As with an uptrend, a downtrend does not carry on in perpetuity. Therefore, a downtrend will either:

• become a sideways trend, when a high is the same as a previous high and when a low is the same as the preceding low.
• change to an uptrend when a series of higher highs and higher lows are confirmed.

 

Trendlines

Trendlines are probably the easiest and most common method to identify trends in forex trading. However, probably one of the most underused methods as well. A trendline is a chart pattern used in technical analysis. Generally speaking, a chart pattern in forex trading is a distinguishable formation, formed by the movements of currencies on a chart. It is a key component of other chart patterns utilised in forex trading, such as wedges, triangles, flags, and head and shoulders. Trendlines are straight lines drawn on a chart by joining a series of highs (peaks) or a sequence of lows (troughs) during a given period of time. Trendlines enables traders to easily identify areas where it is anticipated that the forex market will presumably bounce off of a trendline (support or resistance), or cross a support or resistance trendline, moving in the opposite direction. Put differently, trendlines allow traders to predict levels of support and resistance. A support level is a level where a currency’s price stops decreasing and starts to bounce back, moving higher. A level of resistance is where the price of a currency usually ceases to increase and starts to decrease. If trendlines are drawn carefully and meticulously, they can provide price data as accurately as any other method used in technical analysis. However, trend lines are of little use if they are drawn incorrectly or if traders try to make a trendline fit the market instead of the opposite.   Different types of trendlines:

• Uptrend line

An uptrend line also referred to as an ascending trend line or rising trendline, is drawn at an angle below the price movements of a currency, joining at least two swing lows in an upward direction. (A swing low occurs when price makes a low and is immediately followed by two higher lows in succession.) Hence it is the lows on an uptrend that will determine an ascending trend line. However, to draw a valid uptrend line, at least three lows should consecutively be connected. An uptrend line represents a clear support line, limiting the downside.  

• Downtrend line

A downtrend line is the exact opposite of an uptrend line. It is also called a descending trend line or a falling trendline. A descending trend line is drawn at an angle above the price movements of a currency, joining at least two swing highs in a downward direction. (A swing high refers to a peak reached by a currency’s price before a decline in price.) Express differently, a descending trend line is formed by connecting the highs, where the most recent high is lower than the previous high. Hence, a downward trend line is defined by the highs. Similar to ascending trend lines, descending trend lines are required to join at least three highs to be considered a valid trend line. A downtrend line can be viewed as a resistance level, indicating a price level where rising prices discontinue, change direction, and start to decrease.   Broken trendlines   When a currency price approaches a trend line (rising or falling), one of two things can happen:

1. The price could bounce off the trend line and continue the trend.
2. The price could break out through the trend line and cause a reversal.

All trendlines eventually break, signalling a reversal in price. Currency prices usually test and retest a trend line several times, until it breaks. An ascending trend line becomes resistant to the price of a currency once it is broken. Similarly, once a descending trendline is broken, that trendline becomes a support for the price. Typically, traders use trendline breaks to enter trading positions.   Note: This article does not intend to provide investment or trading advice. Its aim is solely informative.

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