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Determining Currency Trends in the Forex Market

 

Editor’s Note: It is always a good idea to look at charts one or more levels bigger than the time frame that you are trading. If you are trading short term (scalping)  minute by minute look at the hourly and daily charts. If you are day trading by the hour look at the daily and weekly charts to determine the longer term trend. If you are planning on holding for weeks look at the weekly and monthly charts etc. to determine the larger trend.

Currency Trends in the Forex Market

Why is it important to acquire the skill of determining a currency trend in the forex market? For a start, we must have all heard the popular trading phrase “the trend is your friend until it ends”.  In a downtrend, you sell on any short-term rally (reversal) and in an uptrend, you buy on the dips. However, the trader needs to know when these rallies and dips occur. Otherwise, the trader may find himself trading the rallies and dips as changes in trend and not as retracements which they really are, and subject himself to trading losses.

The major reason why traders are unable to detect the true trend is because they do not look at the big picture. To understand the big picture, Forex traders need to understand how the financial markets work. In any market, it is the smart money that moves the market. The smart money is the money belonging to the professional traders (institutional investors, hedge fund managers, etc). They rarely take short term views on the market. For instance, Warren Buffett recently sold off his silver positions which he held since 1997. This typifies the trading sentiment of the smart money investors. They are in it for the long haul. They do not make decisions on what the market has done in 15 minutes or one hour the way the retail investors do.

As such, the first and most important step in determining a currency trend in the forex market, is to look at the market the way the smart money guys do. They look at price behaviour of the currency in view over months or even years. So when retail traders use 15 minutes and one hour charts to try to determine the currency trend, they make a big mistake in doing so. The standard chart used to determine the currency trend in the forex market is the daily chart. A typical daily chart shows the price behaviour of the currency asset over a period of months, which suffices for a time frame analysis according to how the smart money players do it.

To illustrate this point, look at the two charts for gold/USD below:

Gold/Dollar Forex Market

This is the 1hour chart, which seems to show that gold is in a strong uptrend, which has however seemed to stall into a consolidation towards the right hand side of the chart. But is this actually the true picture? Is gold/USD really in an uptrend?

To answer this question, we look to the daily chart as our gold standard for determining the currency trend.

Gold/Dollar Forex Market

We can clearly see that the daily chart shows something very different from the hourly chart. We can see that gold/USD has been in a sustained downtrend since February 2012, and the “uptrend” in the hourly chart is actually just a retracement rally, which has actually stalled on the 38.2% Fibonacci retracement line. In all probability, the consolidation we are seeing on the right side of the hourly chart, is actually because more smart money traders are getting wary of further long positions and preparations are occurring to sell this rally at the 38.2% Fibonacci retracement level. Given that the Stochastics is almost crossing at overbought levels, it is actually dangerous to buy gold/USD at current levels.

What was the eventual outcome of this trade?

Gold/Dollar Forex Market

 

Gold/USD was sold from $1626 to $1560, a 6,600 points move. If a trader had sold 1 Standard lot, this would have been a profit of $66,000. If a trader had been fooled into buying at the consolidation based on the hourly chart, this would have been a catastrophic loss.

Clearly, we can see the value of determining the currency trend in the forex market, and it is always good practice to use the daily chart to get the true picture so as to avoid unnecessary losses.

According to Wikipedia – Forex Market:

The foreign exchange market (forex, FX, or currency market) is a form of exchange for the global decentralized trading of international currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends. The foreign exchange market determines the relative values of different currencies.

About the Author:

This article was written by Adam Green, who has more then 10 years experience trading in the Forex, binary options and commodities markets. He also runs a number of his own financial trading websites with trading strategies and analysis.

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