Whether trends are profitable for you depends on your ability to identify them, measure their strength, and find ways to enter and exit them.
This article will take you through a step-by-step process for trend trading Forex and other assets, by explaining how to act.
Top Forex Brokers
What is a Forex Trend?
A trend is when the market moves in a sustained direction:
- An uptrend is when the market makes a series of higher lows.
- A downtrend is a series of lower highs.
Uptrend and Downtrend
Now, let us look at an actual price chart: the EUR/USD daily chart from 2021 to 2022.
EUR/USD Price Chart 2021-2022
Notice the series of lower highs? Every time the price tries to rise back up, selling pressure comes in at repeatedly lower levels to form a series of lower highs to create a downtrend.
At this point, many traders will add indicators to help, and we will look at some of these indicators in the article. But remember that the price defines a trend. Indicators can help, but they should be secondary to identifying trends because they are derived from price.
The best place to start when looking at a price chart is to mark the highs and lows.
How Do You Know a Trend Has Ended?
There are many different definitions of a trend break, but here is mine:
- An uptrend is over when the price breaks the most recent significant low.
- A downtrend is over the price breaks the most recent significant high.
Breaks of Lows or Highs Questions Trend
When the most recent high or low breaks in a trend, it does not mean that the trend is finished —it may continue. But that initial segment of the trend has stopped, and you should examine the market in a fresh context when that happens.
There are two distinct parts to a trend. The first part is the move in the direction of the trend, known as the “impulsive” move. The second part is the pullback or retracement before the trend continues, known as the “corrective” move. This classification is part of Elliot wave theory.
Impulsive and Corrective Trend Waves
Impulsive and corrective moves each have specific characteristics that can help identify the stage of the trend.
Impulsive moves – moves with force
Candles are mostly (75-80%) the same colour, e.g., bullish, or green candles in a bullish impulsive move.
Candles in an impulsive move generally have shorter wicks.
The longest candles in a chart are mostly in impulsive moves. Longer candles cover more price in less time. That is why you get your profits quicker in impulsive moves.
Corrective moves – reverse the rules for impulsive moves
There is a greater mix of candle colours, i.e., bullish (green) or bearish (red) candles.
Candles are generally shorter, with closes near the middle or in the opposite direction of the impulsive moves.
Candles in a corrective move have longer wicks compared to the bodies.
Corrective moves do not necessarily have to go in the opposite direction of impulsive moves: they can also be sideways (like small ranges within a trend).
Impulsive moves often have fewer candles but cover a lot more distance. In contrast, corrective moves will not cover much price action but will contain more candles.
The above definitions are not rigid or fixed. For example, occasionally, you will see corrective moves with long candles. But the guidelines offer a framework to understand where you are in a trend.
Trendlines
Trendlines connect the major highs or lows of a trend. They can help you see the steepness of a trend and where it may pause before continuing in the original direction.
In an uptrend, you connect the lows, and in a downtrend, you connect the lows.
Trendlines in Uptrends and Downtrends
You only need two points to make a trendline, and more points can be a bonus.
Some traders draw their trendlines without any price breaks through them. Others are less strict and draw trendlines with occasional price breaks if the breaks are small. They may apply a rule that the price cannot have closed above or below the trendline for it to remain valid (particularly on higher time frames, such as on daily and weekly charts).
Price Clustering on Trendline
You can also apply the price clustering concept to horizontal support and resistance lines:
Price Clustering Before Trendline Break
Price clustering around support & resistance has been one of my most profitable signals: it has helped me anticipate the break of a level in advance and given me entry and exit opportunities as the price moves in a new direction.
How to Use Trendlines
If you want to enter a trend, you can wait for the price to reach a trendline for an optimal entry.
If you are already in a trade and the price significantly breaks a trendline, you can use that as a profit-taking tool.
You can use a trendline to trail your stop loss.
Do You Always Need a Trendline?
No, you don’t always need to draw a trendline – it is important not to force one onto your price chart, and instead only draw them where they look obvious. I often do not draw trendlines on my chart because the highs or lows often are not evenly spaced enough to make a line. If I know where the highs and lows are, I will see when the trend breaks.
Adding a Channel Line to the Trendline
You can draw a channel line parallel to the main trendline to capture how the price moves back and forth within the trend.
Using the same EUR/USD daily chart from earlier, let us look at a channel line below the main trendline:
Channel Line with Trendline
You will notice I’ve been less strict in the positioning of the channel line: the price breaks it more often than the main trendline. That is okay because the channel line is more of a guide than a hard rule for the price.
How do you use a channel line? Let us say you want to enter a EUR/USD downtrend and go short. You could wait for the price to get near the top of the channel, then start to make a bearish move, for a good entry.
How Long Can Forex Trends Last?
It is rare for two economies to get hugely out of balance for an extended period relative to each other, especially amongst Forex major pairs like EUR/USD or GBP/USD. In comparison, stocks do not have natural limits – the value of a stock can go to the moon (such as Google over the last twenty years) or even collapse and never return if the company fails.
EUR/USD, the biggest Forex pair by liquidity, is a great example. Looking at EUR/USD over the last 20+ years, you can see how it moves up and down in trends and then rebalances over time:
Long-Term EUR/USD Price Chart Range
Remember, the length of a trend is relative to your time frame. If you are a day trader, a trend lasting a few weeks is a long time. If you are a swing trader using daily charts, a long trend would be a year or more.
Trends vs. Ranges
A trading range is a sideways movement with upper and lower boundaries, i.e., the price moves between support and resistance levels.
USD/CHF sustained a 5-year range from 2015 to 2020
Range-trading requires a different mindset and tools compared to trend-trading:
- In a range, you can take both long and short trades.
- Trend indicators such as moving averages are not valuable in trading a range.
Economic Fundamentals Often Drive Long-Term Trends
Short-term trends are often driven by sentiment, reactions to the news, and even institutions looking to unload orders on their books. Yet long-term trends are driven mainly by economic fundamentals.
Long-term Forex traders use macroeconomic data to build a picture of a country’s economy and currency value. Some of the important economic data that fundamental influenced traders look at include:
- Gross domestic product (GDP)
- Employment levels, e.g., non-farm payroll (NFP)
- Inflation / Consumer Price Index (CPI)
- Interest rate projections
- Consumer confidence
- Industrial production
- Retail sales
- Political risk
Stages of a Long-Term Trend
Accumulation. When a new long-term trend begins, institutions accumulate their positions. This stage is usually when the public sentiment is the opposite of the new trend’s direction, and it is often not clear that a new trend is underway.
Advancing phase. The new trend becomes visible, and the public starts to participate. There is usually real economic data driving the trend. The advancing stage can end with an “excess phase” where uninformed buyers are afraid to miss out. The excess phase creates a steep acceleration of price.
Distribution phase. Informed investors unwind their positions ending the original trend. This phase can be volatile because the excess phase is ending.
Trend-Following Tools: Moving Averages
A moving average plots a line showing the average price of a specified number of previous candles. The average is usually calculated from the candlesticks’ closing prices. There are different types of moving averages:
- Simple Moving Average (SMA) gives equal weighting to each candle.
- Exponential and Weighted Moving Averages (EMA & WMA) gives more weight to recent prices.
What are the most popular moving averages?
- The most popular type is the Exponential Moving Average (EMA).
- The most popular number of candles for moving average calculations are 20, 50, 100 and 200.
How can you use a Moving Average?
- Moving averages can act as effective floating support or resistance once a trend has begun.
- Plotting two (or more) moving average lines can tell you when a trend pauses. For example, if you are in an established trend and see the 10 EMA and 20 EMA come together, that can help provide an entry point.
- When a trend is more volatile and has deeper corrective moves, you will need longer moving average settings, such as the 50 EMA instead of the 20 EMA, because the 20 EMA will continually get broken by the larger corrective moves.
Moving Average Floating Support in Downtrend
Many traders consider the moving average the best Forex trend indicator because it is straightforward and versatile.
Trend-Confirmation Tools: MACD
The MACD (Moving Average Convergence Divergence) indicator measures the gap between two moving average lines and plots it as a bar chart (or histogram), usually below the price chart.
- The most common settings for the MACD are 12, 26 and 9.
- The first two numbers, 12 and 26, are the default moving average settings.
- The last number, 9, is the smoothing period between the two moving averages.
- Most often, the moving averages used in the MACD are Exponential MAs.
Let us look at an example of how MACD can help identify entry points the below EUR/USD daily chart:
MACD Histogram Entry Signals
- When the MACD bars are long, the trend is accelerating. When the bars are short, the trend is pausing, often giving you a point of entry.
- Traders will wait for the bars to become small or change colour to confirm a pullback is over.
- You can use the MACD as a divergence indicator. For example, if the price makes a lower low, but the MACD bars make a higher low, it could mean the downtrend is weakening. However, this technique produces a lot of “false positives” – the MACD will most likely diverge at the end of a trend, but it can also diverge as the trend continues.
Overbought/Oversold Indicator: RSI
The RSI (Relative Strength Indicator) looks to see if the price is overbought or oversold by measuring the size of recent price changes.
- The RSI indicator ranges from 0 to 100, and you can choose where to set the overbought and oversold levels.
- The most common levels are 70 for overbought and 30 for oversold.
- The RSI will look at a specified number of bars for its calculation. The most common setting is 14 bars.
Let us look at an example of how RSI can help identify entry points in a trend in this EUR/USD daily chart:
RSI Signalling Entries in a Trend
When the indicator is in the shaded area, it is within the 30 to 70 band, i.e., neither overbought nor oversold. In this chart, the price never becomes overbought (not surprising because it is in a downtrend), but it does sometimes become oversold.
Point 1:
The downtrend has begun, and it pauses for a while. The RSI indicator is not overbought but is nicely above the mid-level, indicating the price has pulled back to a reasonable level for an entry. It also ties up nicely with a previous resistance level marked with the red arrow.
Point 2:
The price has come down into oversold territory. Point 2 is probably not the best place to get into the trend, as a pullback could be due. As the RSI suggested, the price stopped moving down and moved up for a while.
Points 3 & 4:
The price has come down into oversold territory. Points 3 & 4 are probably not good entry points as a pullback could be due. As the RSI suggested, the price stopped moving down and moved up for a while.
Final Thoughts
Trend trading Forex or any other instrument begins with looking at what the price chart is doing.
A crucial element in trading trends successfully is keeping an eye on the higher time frames such as daily and weekly charts – are you trading in line with the larger trend? Is there support and resistance from the higher time frame that could stall the price? Successful traders rarely focus on a single time frame. They will be viewing at least two time frames to make their decisions. For example, if they enter and exit trades on a 4-hour chart, they should also look at the daily chart.
Most trend traders find that trade entries are much more obvious than exits. Here is an overview of the exit strategies and profit taking tools you can use to exit trend trades:
- Existing support and resistance levels are intelligent places to take profits.
- You can take profit if the trend breaks a recent low (for an uptrend) or a recent high (for a downtrend).
- You may decide to take profits when the price moves a certain distance from your entry-level relative to your risk. For example, if your stop-loss is 50 pips, you may choose to take profits at 100 pips, i.e., double your risk. This trailing stop method is found to be effective by most trend traders, as it is so difficult to pick tops and bottoms accurately.
- If a trend-confirmation tool such as the MACD indicates the trend is changing, you may choose to exit the trade.
FAQs
How do you find trends in Forex?
The easiest method to find trends in Forex is by looking for a series of lower highs (an uptrend) or higher lows (a downtrend). You can also use moving averages to determine whether a trend is present.
What are Forex trends?
A Forex trend is when the price moves in a sustained direction, either up or down.
How do you know if you are in an uptrend or a downtrend?
A Forex trend is when the price moves in a sustained direction, either up or down.
What is the best trend indicator?
A Forex trend is when the price moves in a sustained direction, either up or down.
How do you catch a trend early?
A Forex trend is when the price moves in a sustained direction, either up or down.
How do you know if the price is in uptrend or downtrend?
Look at the price chart without indicators. If you see an obvious pattern of higher lows across the chart, the price is in an uptrend. If you see an obvious pattern of lower highs across the chart, the price is in a downtrend.
What is the best trend indicator?
The best indicator for telling you whether a trend exists is probably the moving average, while the best indicator for showing the strength of a trend is the ADX (Average Directional Index).
How do you catch a trend early?
The best way to catch a trend early is to enter when the price makes a breakout to a new 6-month high or low price, after having been compressed in a relatively tight price range for some time.