Trends are one of the most important aspects of forex trading for successful traders. Understanding that “the trend is your friend” allows profitable trading and helps traders to avoid potential losses. Both technical and fundamental traders use different variations of trend trading and this simple analysis forms part of many trading strategies.

What is the trend?

The trend can be described as the general direction of price over a given period of time. This means that at any one time, and on any timeframe, price will be going in one of three directions: up, down or sideways. For technical analysts, trends are clearly visible from larger timeframes such as the hourly or daily charts which show the general rise and fall of currency values throughout several weeks or years. Although currencies experience price fluctuations each day, the general trend can be seen as the dominant direction as viewed on the larger timeframes. For fundamental analysts, the trend is dominated by the underlying market conditions and fundamental factors such as interest rate forecasting or economic performance. These influences are considered to have a long-term impact on the general direction of a currency’s value.

How understanding the trend can help

“The trend is your friend” is a mantra used by many traders in order to make sure that they make their longer-term trading decisions based on the general direction of the underlying trend. Many traders will look at either the technical or fundamental price trend and then take trades only in agreement with this. The rationale behind this is that the probabilities of a successful trade are increased when this is in agreement with the trend. Technical traders january take the daily trend as an indicator of their intra-day trading on the 5-minute chart. Since these traders know that the daily trend is likely to continue, it is logical to take trades which move in this direction in order to take advantage of the additional momentum.

Fundamental traders will look at both the current situation and future forecasts in order to take a long-term trade on forex pairs. This january be based on the understanding that, for example, the European Central Bank will increase interest rates in the future which will make the currency more attractive to investors. This, alongside other factors, helps to generate a general price trend which can again form the basis of fundamental trading decisions.

Trading using the trend

Technical traders analyse price charts to find opportunities based on familiar and high-probability patterns. Trends are not only visible on higher timeframe charts but also on intra-day charts. Smaller trends form throughout the day and these can be seen as the rise or fall of price to form technical patterns such as channels and trend lines. These can be successfully traded using a number of techniques including buying/selling when price reached the outer lines of these intra-day trends or when price corrects before continuing. Understanding the general, long-term market trend will again assist in making sure that a trade is taken with the highest probability of success.

Buying and selling short-term corrections

Trading pull-backs and market corrections are also a good way to take advantage of trends. Markets never travel in a straight line but the general trend provides the underlying direction. Buying or selling when the market experiences a correction, and therefore moves against the trend, is a good way to insure the best entry price in the direction of the trend.

Technical analysis is a technique used by professional traders to pinpoint profitable market opportunities. The basis of technical analysis is identifying recurring patterns on price charts that have a high probability of pre-empting a future price movement. Technical analysts are not necessarily interested in the fundamental aspects driving the market such as news or events. Instead, they look for specific patterns, levels and indicators within the price charts to guide their trading decisions. These price chart elements allow traders to read markets across any timeframe and, if traded with discipline, can result in the development of a profitable trading strategy.

What is technical analysis?

Technical analysis can range from the simple identification of well-known and heavily traded price patterns to advanced trading strategies utilising multiple complex indicators. Traded in its purest form, technical analysis simply requires access to live price data and a basis of the most popular trading patterns. The reason behind the success of technical trading signals is twofold; firstly these reflect real market sentiment which creates the patterns seen on price charts and, secondly, the fact that the market reacts to these patterns once they occur. Technical analysis in this sense can be described as a reliable self-fulfilling prophecy controlled by the sheer number of traders who adhere to this.

Recognising popular patterns

Some of the most popular technical trades involve the identification of trading patterns such as trend lines, double-tops and head and shoulders patterns. These occur frequently on almost all timeframes and they are also highly reliable. Many technical traders focus on just one or two of these patterns and learn to trade these successfully. Other technical traders will look for technical “areas” of a chart which create support and resistance. These are price levels which have a strong psychological element and include daily pivot levels, Fibonacci retracements and previous highs and lows where the market has reversed. These are typically price levels which attract a larger than normal numbers of market orders which are triggered as price approaches this price level and form either an area of support of resistance.

Trading with indicators

Further variations in technical analysis can involve the use of multiple technical indicators. Whilst some of these have been custom-designed by their creators there are several which have been standardised and are by far the most popular for use by professional forex traders. These indicators can be applied to charting software and are available with the charting software provided by most brokers. Technical indicators range from trend-following indicators to momentum and directional indicators. Broadly speaking, trend-following indicators are described as “lagging” indicators in that they tell you where the market has been whilst momentum indicators are “predictive” and provide an indication of where price january go in the future. Most technical traders would not, however, advise using an indicator as a stand-alone signal to trade but advocate applying this alongside another form of technical analysis, such as the recognition of a confirming price pattern, before entering the trade. An example of this is shown on the chart below with the popular ‘double-bottom’ pattern following an ‘oversold’ indicator on the RSI.

Technical analysis can provide day traders with an edge in the markets

One of the most popular uses of technical analysis is to provide trading signals for intraday traders. The fact that patterns, psychological price levels and indicators can be applied to anything from the 1 minute to the yearly price chart makes it the most popular basis of assessing where the market january move in the future. Although it cannot be 100% reliable as a basis for trading the use of technical trading, and the ability to interpret these, certainly provides january forex traders with a significant edge in the market. Whilst it is recommended that new forex traders learn a handful of the most popular technical signals to begin with, it is true that there are several which are not only very simply to learn but also highly effective. Technical analysis can be made more complex for advanced traders but the edge that this provides january well be negligible over the basics of technical analysis.

Swing trading is all about staying in a trade in order to catch the larger movements in price over several days. Not only does the technique require patience but also a good understanding of risk management as well as a solid trading plan in order to place stops as the trade begins to move your favour. Swing trading also involves reading currency markets in order to take trades as a trend begins to take hold. This can be done using several techniques but begins with the fundamentals of how trend develops, from the end of one price swing to another. The inception of a trend is normally following the ending of a previous price swing when the market flattens and trades in a range whilst bulls and bears fight for the dominant direction. Whilst ranging markets are not favourable for swing traders, they can offer good opportunities for breakouts signalling the start of a new price swing.

Swing trading using Elliot wave theory

Many swing traders are big fans of Elliot wave analysis which explains why currencies move higher in a trend and then pull back to correct at intervals along their way. The smaller swings and corrections within the trend are known as waves and this is where swing traders january hope to add to their positions. Elliot wave theory consists of 5 waves which swing traders count in order to know when an up or down trend is likely to end.

The first of these waves is the ending of a trend in the opposite direction, either through a consolidation period, market reversal or breakout. The ideal situation to enter is on the pull-back of this which forms the second wave, buying or selling against the market and hoping that this is the start of a new trend. A number of techniques can be used to analyse these pullbacks in order to find a good entry to catch the next major price move. This includes watching for candlestick or price patterns which indicate that this is only a temporary correction and the market has changed direction. The third wave is the often the most powerful and the pull-back from this and subsequent fifth wave mark the end of the swing before a more substantial correction.

Trading with trend lines

Trend lines are a swing traders best friend. Not only do they confirm that price is trending but they also mark out key areas of future support for the trend to continue. Linking the lows or highs of the pull-backs in a trend as mentioned above using Elliot waves should result in a diagonal line forming the ‘spine’ of the trend. Trends within the first few waves should find support at these levels and the number of traders seeing these trend lines forming reinforces their strength. Although these are visible on any timeframe, the larger timeframes give more significance to these levels. Swing traders often trade the 4 hourly or daily charts in order to catch the really large price movements, aiming to buy into the trend when price action indicates that the trend line continues to act as a solid support level. This is one of the most effective ways to “buy in to the dips” of a larger swing strade and will ensure the optimum entry.

Swing trading stops

Swing trading is all about managing a position over a period of time. This includes moving stop losses to protect profits whilst still allowing the trade space to breathe. A simple technique used by swing traders is to place stops behind the nearest support level with the theory that once this support is breached the trend january be nearing an end. Using trailing stops such as this will not only protect profits but act as an objective exit in long trades in order to protect a trader from simply holding on to a position beyond the trend and for too long.

As their names suggest, support and resistance act as barriers within forex markets and are easily spotted on price charts either preventing price from moving higher or lower. This can be seen on any forex chart and across all timeframes with those most influential areas of support and resistance potentially still existing in the market years after they were originally created. Both support and resistance in forex trading are known as areas which have historically caused large number of traders to enter the market. Often these areas also have a very large number of automated trades and orders which are triggered as soon as price reaches these levels. The typical battle between Bulls and Bears attempting to push the price lower and higher will result in this area either forming an area of support or resistance. Most often, areas that were previously levels of support become resistance once they have been breached and vice versa.

Why are support and resistance so important for forex traders?

Trading forex using support and resistance can be one of the most effective ways to successfully predict future price movements. Not only do areas of support and resistance show traders the sentiment of the market as a whole, with support and resistance either holding firm or being breached, but it also can show forex traders where not to enter a trade. Support and resistance therefore creates a map of the price chart, showing us where price has previously reversed or bounced and trading strategies can successfully incorporate this knowledge. Having the ability to predict where the majority of market orders exist is a powerful tool which can be learned using the simple analysis of any forex chart.

How to identify areas of future support and resistance

Identifying areas of support and resistance can be most effectively done by zooming out on any price chart and looking at the areas where price has historically reversed, reached a new high or moved sideways. By simply applying horizontal lines to charts where this has occurred will show a trader how significant this area is considered by the market. Those areas of support and resistance which should be considered the most effective are when it can be seen to have influenced price on several occasions. Many of the most powerful areas can be seen on hourly or daily price charts going back several years. When price approaches these levels it bounces off and explains why several market lows can be seen to have reversed at precisely the same point. Similarly, popular tools such as daily pivot points and Fibonacci retracements attract large numbers of order to create support and resistance.

The most effective ways to use support and resistance to trade currencies

Trading these areas of support and resistance can be done in several ways and there are many strategies which use these to confirm a profitable entry. Once of the most straightforward is used by ‘tough traders’ who simply place a reversal order in the market at these critical areas. Once price reaches the trader’s order they anticipate that it will reverse, or at least retrace, and provide them with a profitable trade.

Another less risky way to trade using support and resistance involves waiting for a secondary signal before entering. This can be done successfully using candlestick analysis or applying a momentum indicator or MACD to the charts. Secondary candlestick signals to reinforce the existence of support or resistance january be the existence of a popular reversal pattern around these areas. Another technique is to wait for an area of support or resistance to be broken to confirm the strength of the market move. The fact that markets frequently re-test an area once it has been broken offers opportunities for trades and also confirms that the support has now become resistance or vice versa.

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Scalping is the name given to a forex trading strategy that involves taking small and rapid trades throughout the day often just involving a handful, or even just one or two, pips. The idea behind scalping is for traders to focus on the low timeframes such and the 5, 3 and 1 minute charts in order to spot opportunities to take a small number of pips form the market in a very short space of time. Whilst these techniques january appear to favour those who are impatient and need to be actively trading throughout the day, successful scalpers demonstrate a high level of skill and discipline in their trades. Fast moving and nimble fingered, scalpers often trade similar chart formations and strategies to longer-term traders but apply these to the fast and potentially erratic lower timeframes. Since their exposure to the forex market is generally only a few minutes on each trade, scalpers often argue that their overall risk is lowered compared to swing traders who employ large stops.

Why do scalpers trade forex?

Scalpers are a forex trader who support the notion that little and often is better than one big win every now and then. Those who scalp are looking for consistency over the belief that a trader can lose many more trades than they win provided that the single winning trade counterbalances the losses. Scalpers also do not employ large stop losses and therefore they need to be confident that the positions that they enter have the momentum to rapidly earn them the handful of pips. The reason that these traders exist is that scalping can become a highly successful and profitable way to trade the markets provided a trader can demonstrate highly-disciplined stop and profit targets. Forex markets are also idea for scalping as they provide a high level of both momentum and liquidity which are very important to enable traders to move in and out of positions without a problem.

What to look for as a scalper?

Scalpers have a tendency to hold a position for just a few minutes, or less, depending on the speed that the market is moving. Ideally, because scalping only requires a trader to obtain a small number of pips, the favoured forex pairs are going to be those with the lowest spreads. Low spreads mean that price has to move fewer pips in order to achieve its profit target, and pairs such as the EUR/USD are ideal with typically some of the lowest spreads of all currency pairs.
Another important aspect to scalping is to have a tried and back-tested strategy to follow, including strict entry and exit rules. The discipline to be able to follow the rules of the strategy is as important as the technique itself and the application of tight stop-losses makes the probability of momentum in the trade particularly important. Whilst swing and day traders can accept that prices january move higher and lower, employing wider stop-losses to take account of these, scalpers cannot afford to endure large losses. Such losses would make their profit:loss ratio impossible to sustain even for a very good trading strategy.

Automated trading and scalping

Many automated trading systems use a similar technique to scalping, as many strategies are rule-based and ‘mechanical’ in their entry and exits. Successful automated scalping strategies are, however, difficult to come by on the commercial market. Those to avoid are clearly those that claim to make very large profits “whilst you sleep”, or similar. Nevertheless, one of the benefits of the relative simplicity of automating a scalping strategy is that this makes it very straightforward to test over a longer and more diverse period of time. Whilst a sensible trade size is central to scalping with success and maintaining a positive account after incurring losses, a comprehensively back and forward-tested scalping strategy helps traders to optimise many important parameters including trade size, time of day and throughout different market conditions.