The first thing I struggled with when I started trading the forex market is to learn how to identify the trend in forex charts.
As easy as it seems, finding the trend in a price chart can be quite challenging since every trader has a way of drawing the trend line. This is why it is considered one of the most controversial topics in technical analysis.
Because the way that each trader determines the trend in a market is totally subjective to the way he perceive the concept of a trend. Some use technical indicators to help them identify the trend in forex, while others use pure price action and multiple timeframe analysis to find the long-term or short-term trend.
In forex, where strong trends tend to develop often as major economic data seize the market for sometimes months at a time, trend trading is the preferred strategy of choice.
This is why, in this article, I will show you the 3 easy methods you can use to identify the trend in forex charts in a matter of seconds.
What is a Trend?
The basic definition of a trend is a series of higher lows for an uptrend and a series of lower highs for a downtrend. As you can see on this chart, during an uptrend price creates a series of higher highs and higher lows and while in a downtrend, price forms a series of lower highs and lower lows.
The price action of both an uptrend and a downtrend is rarely perfect. In fact, it has a zig zag pattern as prices are moving up or down.
In real life, prices are constantly correcting and retracing back. These movements make traders stressful as they lose track of what is really happening in the market. It takes a great amount of experience to distinguish between market corrections and change in the overall trend in forex market.
Thus, a trend is purely defined by the price action of the lows in an uptrend and highs in a downtrend. Although most traders still define a trend as a series of higher highs for an uptrend and lower lows for a downtrend.
Technically speaking, an uptrend is a failure of prices to drop lower and the exact opposite for a downtrend. In fact, during an uptrend, buyers exceed sellers and more buyers are stepping in to buy every decline in prices.
During a downtrend, sellers exceed buyers and with every pullback more sellers are more sellers are selling for every retracement sellers perceive it as an opportunity to sell even more.
To make it easier for you to identify the trend in forex charts, I will show you 3 easy methods you can adopt in your technical analysis arsenal to determine the trend in a few seconds.
Method 1: Highs and Lows
The first method to identify the trend in forex is based on pure price action where you identify the last highs and lows to determine the trend.
The method is pretty straight forward as you start at the current price and work your way up or down to identify two pivot highs and two pivot lows.
In case of an uptrend
When price creates a higher high (HH) and a higher low (HL) followed by a higher high (HH) and a higher low (HL), the trend is up.
In case of a downtrend
When price creates a lower high (LH) and a lower low (LL) followed by a lower high (LH) and a lower low (LL), the trend is down.
When price creates equal highs and equal lows, the price is moving sideways in a range.
Method 2: The Trend Lines
The second method to identify the trend in forex or any other market is the use of trend lines. This is one of the most popular method used by all traders from beginners to advanced. Despite the fact that most traders consider it a useless tool, if you are trading forex with supply and demand strategy you must know how to draw your trend lines to confirm supply and demand zones as valid price levels.
The premise behind the trend line is that in an uptrend the trader should draw a single straight line connecting the lowest swing low to the highest swing low and do the reverse in the downtrend.
The idea is that price will then respect these lines, which act as support and resistance for the price.
When price breaks the trend line, you could expect a change in the current trend. Usually, it is a sign that the trend may be ending. What follows the end of a trend and before a reversal is a consolidation period where price keeps moving sideways until it finds enough power to move in the opposite direction.
So how can you be sure that the break of the trend line is valid?
The first thing you should confirm is that price should close beyond the trend line. In the case of a downtrend the close would have to be above the line. In the case of an uptrend the close would have to be below the line. If price has closed above or below the trend line, then you can expect a change in the market sentiment.
Method 3: Moving Averages
Another method you can use to help you identify the trend in forex charts is the use of moving averages. Unlike trend lines, moving averages are more sophisticated technical tools based on mathematical calculations that give us definitive measures of resistance and support with great precision.
Moving averages are widely used in technical analysis by most traders. They are easy to plot on a chart and give almost an instant idea about the current trend of the market. Traders use different combinations and different types of moving averages to gauge whether the market is trending up, trending down, or simply moving sideways.
Here, I am going to talk mostly about simple moving averages to give you a simple method of gauging the trend. For example, to construct a 20-simple moving average on a price chart a trader would have to add each price close and divide by 20.
As each new period is added, the oldest period is dropped off and the average is recalculated. Simple moving averages are very much a lagging indicator, but they are very important to technical analysis nevertheless because they represent the consensus price of the market.
The most basic analysis states that if prices trade above a certain average they are in an uptrend and if they trade below they are in a downtrend. If the moving average is cutting through prices they are in a consolidation or a sideways movement.
Often traders use a combination of two or more moving averages to get trading signals from the price action. For example, a combination of a 20 SMA and a 100 SMA as shown on the chart below.
As the 20SMA crosses above the 100SMA, the market is trending up and when the 20SMA crosses below the 100SMA the market is in a downtrend. This is useful because both moving averages work in tandem to help filter out bad trades from the good ones.
Whether you use trend lines, moving averages, or even price action to identify the trend in forex, your main focus should be on getting an idea about the bigger picture instead of getting lost in small price movements.
In general, your job as a trader is to gauge the overall trend of the market; is it in an uptrend or a downtrend?
Contrary to popular opinion, identifying a trend is not nearly as difficult as it may seem. It certainly requires practice and many hours in front of your screen to master it like any other subject. While finding the trend in forex charts may seem easy, trading it is not.