Forex Masters - Learning to Indentify Trends

Learning to identify trends in the market is the most fundamental, basic necessity of technical analysis. It is the foundation that all other technical analysis is built on.

Note: See below for the difference between technical and fundamental analysis.

TECHNICAL ANALYSIS

The method of analysis based on market action through chart study and various technical indicators. Simply put, it’s the study of the relationship between time and price. Technical analysis is the preferred method of trading for most professional traders, especially Forex traders.

FUNDAMENTAL ANALYSIS

Fundamental analysis is trading based on following political and economic factors that move the market rather than studying charts for trading signals. News such as interest rate changes, unemployment rates, and trade deficits are all examples of factors considered in fundamental analysis.

Using trendlines is one of the very best methods to determine the trend in the market and significant market turning points. Many traders underestimate the importance of using trendlines and how valuable they can be for helping to predict significant price movements. Many traders, unfortunately, do not know how to correctly draw trendlines. In this lesson you will learn how to draw trendlines correctly and how to use them to help you identify trends.

Traders draw trendlines to help them determine a trend, its strength, and at what point the trend could reverse.

When prices incline in a rally, you draw a line across the bottoms, below prices.

To draw a trendline, start your line at the first major bottom of an incline (marked ‘A’ in the chart below) and connect it to a second major bottom of the incline (marked ‘B’ in the chart below).

As you can see from this simple example, when you draw a straight line from A to B you get an upward sloping trendline which signifies an uptrend. It is better to draw trendlines across congestion areas rather than extreme highs or lows; many beginners fail to recognize this important point. Since the majority of trading is done at the congestion areas, you'll want to draw your trendline across these areas, rather than spikes, as this will give you a stronger signal as to what the trend will be. As you can see at point C, what was previously support now becomes resistance. You will learn more about support and resistance levels in the FXTT Forex trading course.

The following is an example of a weekly chart based on the Swiss Franc/USD. In this chart you see an uptrend, a downtrend, and a trading range.

A. This trendline signifies the downtrend from October of 1989 to August of 1990. You can see it was drawn from the highest congestion area down to the next congestion area downward, which then projected the trendline all the way down to a little past 1991. The slant of this trendline signifies a very strong downtrend, which you can see lasted quite a long time.

B. This is the trading range from about August of 1990 to about February of 1991. You can see that for a seven months the Swiss Franc was in a sideways-long-term trend (trading range), but still had about a 700 pip short term trading range. In that time period, this weekly chart would be helpful to look at and draw the trendlines for the trading range to see that there were major upside and downside barriers to price movements in that time, and that one should "go long" near the bottom of the range, and "go short" near the top. You will learn the basics of "going long" and "going short" in the FXTT Forex trading course.

C. This trendline signifies the uptrend from February 1991 to about July of 1991.

D. You can see that after the up-trendline was broken, prices pulled back to the trendline, and then fell sharply downward. Anytime you see prices pull back almost exactly to a trendline after breaking a trendline, and then begin to go back in the direction of the break in the trendline, then this may indicate a higher probability that the trend will reverse.

When major trendlines are broken, especially on very long term charts, it often signifies a major Market turning point, and thus a good strategic entry point on a new trend.

In the above example of a daily chart based on the GBP/USD, there is a decline of over 600 pips in just two weeks after the major three month up-trendline is broken.

In the above example of a daily chart of the EUR/USD, a sizable rally of over 500 pips came after the major trendline from May to July was broken.

As you can see, trendlines can be a very powerful and effective, yet simple tool to help you determine trends and improve your trading strategy.

Let’s take a look at an example of a recent trade those trading breakouts made, and how a trendline confirmed the trade.

This AUD/USD trade was entered "long" on September 9th at 1.6548. This is an unusually long yet extremely profitable trade on this currency pair. The trend reverse level was broken, and the second and third confirmation came on the very same day that prices broke through this down-trendline, giving a strong indication that this could be a high probability winning trade.

Risk Disclosure: 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 invest in 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 advisor if you have any doubts.