A trending market is
one in which price is generally moving in one direction.
Sure, price may go against the trend every now and then, but
looking at the longer time frames would show that those were just retracements.
Trends are usually noted by "higher highs" and
"higher lows" in an uptrend and
"lower highs" and "lower lows" in a downtrend.
When
trading a trend-based strategy, traders usually pick the major currencies as
well as any other currency utilizing the dollar because these pairs tend to
trend and be more liquid than other pairs.
Liquidity is important in trend-based strategies. The more liquid
a currency pair, the more movement (a. k. a. volatility) we can
expect.
Check out Huck's EUR/USD win from
following the trend.
The more
movement a currency exhibits, the more opportunities there are for price to
move strongly in one direction as opposed to bouncing around within small
ranges.
Other
than eyeballing price action, you can also make use of technical tools you have
learned in previous sections to determine whether a currency pair is trending
or not.
ADX in a Trending Market
A way to determine if the market is trending is through the use of
the Average
Directional Index indicator or ADX
for short.
Developed
by J. Welles Wilder, this indicator uses values ranging from 0-100 to determine
if price is moving strongly in one direction, i.e. trending, or simply ranging.
Values
more than 25 usually indicate that price is trending or is already in a strong
trend.
The
higher the number is, the stronger the trend.
However,
the ADX is a lagging indicator which means that it doesn't necessarily predict
the future. It also is a non-directional indicator, which means it will report
a positive figure whether price is trending up or down.
Take a
look at this example. Price is clearly trending downwards even though ADX is
greater than 25.
Moving Averages in a Trending Market
If you're not a fan of the ADX, you can also make use of simple moving averages. Check
this out!
Place a 7
period, a 20 period, and a 65 period Simple Moving Average on your chart. Then,
wait until the three SMA's compress together and begin to fan out.
If the 7
period SMA fans out on top of the 20 period SMA, and the 20 SMA on top of the
65 SMA, then price is trending up.
On the
other hand, if the 7 period SMA fans out below the 20 period SMA, and the 20
SMA is below the 65 SMA, then price is trending down.
Bollinger Bands in a Trending Market
One tool that is often used for range-bound strategies can also be
helpful in trend discovery. We're talking about Bollinger bands or just
Bands.
One thing
you should know about trends is that they are actually quite rare. Contrary to
what you might think, prices really range 70-80 percent of the time. In other
words, it is the norm for price to range.
So, if
prices deviate from the "norm" then they must be in a trend right?
What is one of the best technical tools we have mentioned in the previous
grades that measure deviation?
If you
said a ruler, we give you mad props for effort.
If you
said Bollinger bands, we'll give you cyber milk and cookies! Here, take some.
Bollinger
bands actually contain the standard deviation formula. But don't worry about
being a nerd and figuring out what that is.
Here's
how we can use Bollinger bands to determine the trend! Prepare for the
craziness.
Place Bollinger bands with a standard deviation of 1 and another set of bands with a standard deviation of 2. You will see three set of price zones: the sell zone, the buy zone, and the "No-man's Land."
The sell zone is the
area between the two bottom bands of the standard deviation 1 (SD 1) and
standard deviation 2 (SD 2) bands. Bear in mind that price has to close within
the bands in order to be considered in the sell zone.
The buy zone is the
area between the two top bands of the SD 1 and SD 2 bands. Like the sell zone,
price has to close within the two bands in order to be considered in the buy
zone.
The area in between the standard deviation 1 bands is an area in
which the market struggles to find direction. Price will close within this area
if price is really in "No-Man's
Land". Price direction is pretty much up for grabs.
The Bollinger
bands make it easier to confirm a trend visually.
Downtrends
can be confirmed when price is in the sell zone.
Uptrends
can be confirmed when price is in the buy zone.
