Trending Market
A trending market is one in which price generally moves in one direction. Sure, the price may go against the trend now and then, but looking at the more extended 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 and any other currency utilizing the dollar because these pairs tend to trend and be more liquid than other pairs.
Liquidity is essential in trend-based strategies. The more liquid a currency pair, the more movement (a.k.a. volatility) we can expect. The more movement a currency exhibits, the more opportunities for price to move powerfully in one direction instead of bouncing around within small ranges. Other than eyeballing price action, you can also use the technical tools you have learned in previous sections to determine whether a currency pair is trending.
ADX in a Trending Market
A way to determine if the market is trending is by using 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 the price is moving intensely in one direction, i.e., trending or simply ranging. Values more than 25 usually indicate that the 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, meaning it doesn’t necessarily predict the future. It is also a non-directional indicator, which means it will report a positive figure whether the price is trending up or down.
Moving Averages in a Trending Market
If you’re not a fan of the ADX, you can also use 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 SMAs 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 the price is trending up.
On the other hand, if the 7-period SMA fans are out below the 20-period SMA, and the 20 SMA is below the 65 SMA, then the price is trending down.
Bollinger Bands in a Trending Market
One tool 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 pretty rare.
Contrary to what you might think, prices range 70-80 percent of the time. In other words, it is the norm for the price to range. Bollinger Bands 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 (SD) of “1” and another set of bands with a standard deviation (SD) of “2”. You will see three price zones: the sell zone, the buy zone, and the “No Man’s Land.”
The Bollinger Bands make it easier to confirm a trend visually. Downtrends can be confirmed when the price is in the sell zone. Uptrends can be confirmed when the price is in the buy zone.