Trading Trends in Forex
Updated: March 27, 2013 at 8:39 AM
One of the most popular sayings heard on Wall Street just has to be, "The trend is your friend". Read more forex trading words of wisdom.
By this, a trader is intending to communicate that the big money in trading often comes from following major trends or directional movements occurring in the markets.
Traders will typically profit from this situation by identifying trends and then holding positions that benefit from an overall continuance of price movements in the direction of an established trend.
The following sections cover how traders identify trends, manage their money and trade trends in the forex market in currency pairs against the U.S. Dollar and in the crosses.
Using Channels and Trend Lines
Forex traders using technical analysis to identify trends will often draw a couple of straight trend lines on price charts. The first of these lines is drawn through the low points of the price action where the market was going lower, but reversed higher. The second line will be drawn through the observed price highs where the market was heading higher, but reversed lower.
When this pair of lines runs roughly parallel to each other then the pattern they create is known as a channel. A channel can be used to identify a trend in progress, as well as to provide measured move objectives if it is broken by the price action.
If the lines are not parallel, but still supported by a considerable number of reversal points, they still might be used by a forex trader to indicate support or resistance levels that may well affect the price action going forward.
Also, if the lines are moving in the same direction, i.e. up or down, then that will tend to indicate that a trend is in progress in that direction.
Managing Money When Trading Trends
Traders following trends will usually benefit from employing good money management practices to help mitigate their risk and protect their profits. Read more on money management.
One way they might do this is by using trailing stop loss orders that will protect their position and any accumulated profits in the case of a significant market reversal, while at the same time permitting their profits to run as high as possible.
Trading the U.S. Dollar's Trend
Many large currency moves are either in favor of or against the U.S. Dollar. This occurs largely because the United States' currency is the most traded national currency in the world and it has maintained its status at the forefront of reserve currencies held by various countries' central banks since the Bretton Woods agreement of 1944.
In essence, the U.S. Dollar often acts as the currency market leader and its value will often rise or fall against many currencies simultaneously depending on the economic outlook for the United States relative to that for the rest of the world at the time. This can give the impression of overall bull or bear markets for currency pairs that involve the U.S. Dollar.
Also, this widespread involvement of the U.S. Dollar in the forex market, as well as the currency's tendency to trend, provides traders with numerous different ways to take views on the U.S. economy with respect to the economy of other countries.
Trading Trends in the Crosses
Since other major currencies also trade actively against each other, they offer an alternative to trading in currency pairs that include the U.S. Dollar. See all the major currency pairs.
Such currency pairs are known as cross rates and they make up a somewhat less traded, but still liquid, part of the forex market. Nevertheless, trading in these cross rates can be just as profitable, or even more so, than trading exclusively in currency pairs that include the U.S. Dollar.
Furthermore, although correlations between different currency pairs can be positive or negative, each currency pair acts as its own trading instrument. As a result, a particular currency pair does not have to follow the same trend as all other currency pairs.
For example, one currency pair can be showing a bull market or up trend, while another can be trading in a bear market or down trend. This gives a forex trader considerable flexibility in choosing their optimum trading vehicle to profit from.
Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.