One of the technical analysis terms that is most commonly used in the forex markets is the “price trend.” This essentially refers to the dominant direction of a currency pair over a certain time period (short term, medium term, or long term). Since prices can only travel in three directions (upwards, downwards, or sideways), one of these directions will be used to describe the general trend of the currency pair you are watching.
As you might have already guessed, understanding the general direction of a currency can be vital in constructing trading ideas After all, we need to have some idea of which direction prices are expected to travel before we can commit money to a position (uptrends for buy positions or a downtrends for sell positions). But at this stage, you might be thinking about some of the charts you have seen in the past. Likely, you have seen many charts where no clear trend can be deciphered. So, what do technical traders do in these cases? How is the overall trend typically determined?
Guest post by Richard Cox of NordFX
Determining Trend Direction
In fact, there are a few different ways that trends can be identified. “In an uptrend, we make it our definition to see a series of higher highs and higher lows,” said Ann Gorenkova, currency analyst at NordFX “Conversely, a downtrend will be seen with a series of lower highs coming along with a series of lower lows.” If neither of these conditions is present, the chart will be considered “sideways” or directionless, with no clear direction present.
Next, we must understand how to use this information in order to construct trading plans. One of the most common phrases in the forex market is that the “trend is your friend, stick with it until the end.” And since the trend is where the majority of market momentum is situated, this is usually viewed as good advice to follow. Because uptrends will show us that the majority of the market is looking to push prices higher in a particular currency, there is a greater likelihood that our trades will be successful if we latch on to that momentum and enter into “buy” positions.
At the same time, downtrends tell us that the majority of the market is expecting prices for a currency to decline. Since this is where most of the money is already invested, we can benefit from this directional momentum and enter into “sell” positions for a currency. In the third scenario, where there is no clear trend to identify, it is usually best just to stay on the sidelines and wait for a better opportunity before getting into new positions. In these cases, it should always be remembered that there is nothing wrong with keeping a neutral position, as unnecessarily getting into a trade will likely only lead to losses and negatively influence your long term profit and loss ratios.