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In forex, a trend happens when the price of a currency pair moves in a particular direction for a certain period. This movement can be upwards, downwards, or sideways and can last for a few days, weeks, or months.
But what makes a trend so important? For any trader in the market, the ability to identify trends from the start and capitalize on them can define your level of success. Looking out for strong trends in currency pairs allows you to determine which pair is going to be the most profitable within a given time frame and the best time for you to enter a trade.
At the same time, accurately identifying a trend can protect you from losses by giving insight into the most appropriate time to exit the market to protect, your investments. This is why every investor both new and experienced, is constantly looking for ways to improve their knowledge of the forex market and discover better ways to easily identify trends. Here are some methods you can use to do just that.
Why does a change in trend happen?
Nothing stays the same for long and that certainly holds true in the forex market. If there is one thing forex traders have come to expect, it is that price movement can change direction at any minute and they have to always be ready for it. But these changes don’t happen for no reason.
Trend changes can happen due to:
- Growth/decline of the economy: The government has a massive influence on a currency due to the policies it set. If the policies are favorable and allow the currency to easily be traded, its value will increase and vice versa if the policies are not favorable.
In addition, countries with strong economies tend to have strong and high-value currencies as well. If the economy of a country is experiencing some decline, this will cause its currency to weaken against its pair.
- Expectation/ Market sentiment: An investor’s belief about the future of a currency, can affect its value. When investors or traders believe that the value of a currency is going to rise, they are going to buy more of it and before you know it, the currency will go into an uptrend.
However, if investors or traders believe that a currency is going to weaken, selling will increase and the currency will go into a downtrend except buyers can absorb the selling pressure.
- Supply and demand of that currency: Demand has to do with how much of a commodity people want and supply measures how much of a commodity is available for people to buy at a given time. The value of a currency is directly linked to its supply and demand. In the case of supply, a currency tends to decrease when its supply is more than the demand for it or what buyers need at the moment. When that supply is decreased, the currency becomes more valuable.
However, demand doesn’t have the same effect on a currency. In fact, the value of a currency increases when the demand for it is high and there will be a decrease in value when there is little demand for the currency at that time.
How to Know When a New Trend is about to Happen
These are some techniques you can use to confirm trend changes:
1. Identify highs and lows
The easiest way to identify a trend is to spot price action with your eyes. For this method, all you have to do is look at the highs and lows in a chart to determine the direction of the currency pair.
For instance, if you are seeing higher highs and higher lows, this can be an indication that the price is about to go in an uptrend. But where there are lower lows and lower highs, it could be an indication that a downtrend is about to take place.
In some cases, this movement is easy to spot but more often than not, these changes will not always be so obvious but there will still be some signs that the price is moving forward.
This technique is one of the easiest and most straightforward because it doesn’t require any technical indicators as you will solely rely on proven action. However, it shouldn’t be the only thing you use to determine whether or not a trend is taking place.
2. Use the abandoned baby bullish pattern
This is a three-candlestick pattern that signifies that an uptrend is about to take place. It is used by traders along with other indicators to determine when would be the best time to enter a buy position.
The pattern consists of a large bearish candle as the first candlestick, followed by a Doji candle that gaps that, and a bullish candle as the third candlestick in the formation.
It is quite similar to the evening star pattern and shooting star pattern in its appearance, with its significant difference being the Doji candlestick in the middle.
To identify the bullish abandoned baby pattern, it must appear at the bottom of a downtrend, and there must be a Doji candlestick in the middle of the formation followed by a bullish candlestick; it doesn’t matter whether the Doji is neutral or bearish.
To prevent acting based on false signals, it is important to use trend reversal momentum indicators along with the pattern in order to verify the incoming trend.
The other form of this bullish pattern is the bearish abandoned baby pattern that is used to indicate the start of a downward trend in a chart. Unlike the bullish version of this pattern, the bearish abandoned baby appears at the top of a trend, and it is also composed of three candlesticks. Traders use this pattern and other indicators to determine the best time to exit a buy position or open a short one.
HowToTrade shows how to trade the Bullish Abandoned Baby pattern for anyone who wants to learn more. They’ve got plenty of experts in the matter, so you’d be in good hands.
3. Include fundamental analysis
Using fundamental analysis to identify a trend means focusing on economic factors like inflation, manufacturing activities, gross domestic product, and economic growth. Basically, fundamental analysis is a technique that involves studying the economic strengths and market news of various countries to understand how their currencies are going to move and make accurate predictions based on that.
Why should you do this? As earlier mentioned, economic events and geopolitical happenings tend to have a strong influence on how currencies behave. Technical analysis alone isn’t enough to accurately predict a currency’s direction and fundamental analysis is needed to complement the information gotten from technical analysis. It is also a good way for beginners to learn the various factors that can influence forex trading in the market.
To keep up with all the relevant economic events and predictions, traders use an economic calendar. This calendar contains all the latest and relevant information that can affect volatility in the forex market and it is crucial for successfully identifying new trends before they fully begin.
4. Use three SMA filter to determine the strength of the trend
A moving average is a trend indicator but they are also lagging indicators which means that using it alone makes it difficult to catch on to early trends. The MACD is another technical indicator that helps spot trends. Along with other technical indicators, having three SMA on your chart in different lengths helps to filter out market noise and gauge if the approaching trend is strong. This way, you won’t trade based on false signals and can take advantage of early trends as well.
It is advisable to use a short term, long term and an intermediate SMA together as a filter and when all three SMAs align in one direction (usually the direction of the price movement) it is an indication that the trend is strong.
Use everything at your disposal
In the forex market, nothing is completely black and white and there is no perfect method to predict when a trend is going to change. The best thing you can do to make accurate predictions is extensively consider the information in front of you and include technical indicators like Fibonnaci levels, chart patterns, trend lines, and momentum indicators in your research and analysis.
Doing this gives you a better chance of minimizing mistakes and making the most out of new trends.
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