direction.
You can easily gauge the direction of a trend by looking at the price chart of a
currency pair. A trend can be defined as a series of higher lows and higher highs in
an uptrend, and a series of lower highs and lower lows in a downtrend. In reality,
prices do not always go higher in an uptrend, but still tend to bounce off areas of
support, just like prices do not always make lower lows in a downtrend, but still
tend to bounce off areas of resistance.
There are three trend directions a currency pair could take:
1. uptrend,
2. downtrend or
3. sideways.
1. Uptrend
In an uptrend, the base currency (which is the first currency symbol in a pair)
appreciates in value. For example, if EUR/USD is in an uptrend, it means that EUR
is rising higher against the USD. An uptrend is characterised by a series of higher
highs and higher lows. However in real life, sometimes the currency does not make
higher highs, but still makes higher lows. Base currency bulls (henceforth referred
to simply as “bulls”) take charge during an uptrend, taking the opportunities to bid
up the base currency whenever it goes a bit lower, believing that there will be more
buyers at every step, hence pushing up the prices.
2. Downtrend
On the other hand, in a downtrend, the base currency depreciates in value. For
example, if EUR/USD is in a downtrend, it means that EUR is declining against the
USD. A downtrend is characterised by a series of lower highs and lower lows, but
similarly, the currency does not always make lower lows, but still tends to make
lower highs. The downward slope of lower highs is formed by the base currency
bears (will simply be known now as just “bears”) who take control during a
downtrend, taking every opportunity to sell because they believe that the base
currency would go down even more.
3. Sideways trend
If a currency pair does not go much higher or much lower, we can say that it is
going sideways. When this happens the prices are moving within a narrow range,
and are neither appreciating nor depreciating much in value. If you want to ride on
a trend, this directionless mode is one that you do not wish to be stuck in, for it is
very likely to have a net loss position in a sideways market especially if the trade
has not made enough pips to cover the spread commission costs.
Stages of a Trend
A trend has a start point and an end point; in between these two points, the trend
can exhibit different behaviours. As a trend rider, it is important to note the various
stages of a trend so that you don’t get on the trend train at the last stage, just when
smart people are starting to disembark from it. The stages of a trend are not clearcut,
and that includes the starting and ending stages; and each stage can vary in
length of time.
Let’s take a look at the different stages of a trend .
1. Nascent trend
2. Fully charged trend
3. Aging trend
4. End of trend
Stage 1: Nascent trend
Right after a reversal, the embryonic trend emerges into the new territory with the
greatest amount of uncertainty, as traders have the least amount of confidence in the
direction of the nascent trend. Price moves are often sharp, and may even retest the
price levels seen before the entry into the new territory as bulls and bears wrestle for
power. This characterises Stage 1 of a trend, and it is where aggressive traders get
into the currency market, hoping to be right about the new direction of the trend and
reap potentially the most profits by getting in early. Since this stage of the trend has
the greatest level of uncertainty, it is also where the risk of trend failure is greatest.
Stage 2: Fully charged trend
By the time the trend reaches Stage 2, it is fully charged. Either the bulls or the
bears have won the battle over the other by now, and are persistently pushing the
currency prices higher during an uptrend, or lower during a downtrend. The highly
confident behaviour of the bulls in the uptrend and of the bears in the downtrend
gives little room for uncertainty about the trend direction. This stage is ideally the
best time for the risk-averse trader to join in the prevailing trend, after getting
confirmation from the technical picture and market sentiment.
Stage 3: Aging trend
As with human beings, a trend gets old and tired eventually. Aging of a trend
typically occurs in Stage 3, and it is at this stage that you can witness the fallacies
of man. Overly eager traders, especially those who have missed out on the initial
stages of the trend, are now realising their tardiness, and are hopping onto the trend
bandwagon, hoping to still be able to get a piece of the action. The more experienced
traders are more than happy to pass on the closing legs of their transactions over to
these inexperienced traders as they try to take their profits while the trend is near the
peak of an uptrend, or near the bottom of a downtrend. Seasoned traders begin to
lose their confidence in the strength of the trend, whereas inexperienced traders who
are still hoping to gain more profits remain optimistic about the trend. So there is a
mix of waning confidence and overconfidence in the trend at this stage. More price
consolidation periods could be seen at this stage, and chart patterns like head-andshoulders
or double top/bottom are commonly found here.
Stage 4: End of trend
The last stage is when the trend begins to crumble and lose its staying power. In an
uptrend, shortage of bullish newcomers halts the advance of higher prices, and
some begin to take their profits, pushing the prices lower and lower. In a
downtrend, a lack of new bears coming into the market stops the currency prices
from going lower, and when they start to take profits, prices start going up. The
crumbling and ending of a trend can come fast and furiously, without much warning
to traders, or it can be a more prolonged process as power changes hands between
the bulls and bears. Usually a trend reversal is brought about by a major change in
the underlying sentiment about a currency. Jumping onto this stage of a trend in
order to ride the underlying trend can be very risky as the trend is close to ending,
and there is a high chance of the trade getting stopped out.
The most profitable entry points into a trend are at Stages 1 and 2, where the
potential for the trend to grow and continue is great. Profit potential at Stage 3 may
be limited as the trend has matured, and it is where most profit-taking takes place.
When it comes to riding a trend, potential for loss becomes huge when getting in at
Stage 4.
Source: 7 Winning Strategies for Trading Forex: Real and Actionable Techniques for Profiting from the Currency Markets
