The basic profit in forex, as in any liquid, market-based investment, is knowledge. If you can accurately predict where the market is going and do so consistently, you’ll be a very rich person. But there are multiple components to making successful predictions. Obviously, you have to know what direction the market is moving. You also have to know something about timing. And one of the least recognized – you should know how strong the movement is.
For instance, you might accurately predict an upward trend beginning at a certain time. If the trend continues for only half of the distance you expected, the trade might not even be worth the spread you paid, or if it goes twice the distance, you will lose out on a much greater opportunity.
So how do you gauge the strength of a movement?
The bad news is that it is really quite hard. The only fundamental way to do so is to know the market and the pertinent information that is driving it. For instance, a major news break that influences economic conditions for a national player is going to cause a long and powerful trend. Know the currencies you are trading and the countries they represent so that you have a context for interpreting events.
Watch the volume
But this is hardly the method that most traders hope to use, since it is rare for this kind of analysis to work. The best method is to watch volume. This information is not as readily available for forex as for stocks, but most brokers do make it available in some form. The principle is that if large amounts of currency are trading hands, something major is happening. This usually points to a deeply-rooted change in the market that will result in a major trend-market strength.
The practice is far less common, but traders can perform Fibonacci analysis on volume as well as they can with prices. Look for pivot points and trends just as you would with your other analysis. If volume peaks and stops, expect the trend to stop soon after as well.
Use an ad hoc basis
Finally, the most pragmatic but least satisfying way to measure market strength is on an ad hoc basis. You know that a trend is finished when it stops. This is where you can use technical indicators and traditional analysis techniques to assess what is happening. If the market turns more steady or goes back in the other direction, it’s time to exit. This is why it is important to have stop loss measures in place. If possible, put in more complex stop losses that sell based on a percentage lost from your highest point. In other words, if the market goes up and then starts to dip, you want to sell before riding it all the way back down.
These three methods demonstrate an interesting dynamic. On one extreme, fundamental analysis offers core assessment of what is happening at the foundation. On the other extreme, measuring trends as they develop is the most pragmatic and is directly connected to what is happening. But the best blend of the two is in measuring volume, where you get some predictive value while also being connected to what is happening. Of the three, the best results do come from volume analysis, but the ultimate results come when you use the methods together to form a full picture. If done right, you can make a reasonable guess at forex trend strength.