The forex market is a very dynamic one characterized by upward and downward movements in price. These movements tend to move in an overall direction referred to as a market trend. A trend is therefore the general direction in which the price of a specific currency moves.
It is generally believed among forex traders that the longer the duration of a trend, the more the potency. There are three major trends namely: Upward (bullish) trend, downward (bearish) trend, and sideways trend (Range). The interesting thing about trends is that different kinds of trends can co-exist together without any contradiction at all. There are trends within trends.
Taking the monthly time frame for example, there can be one overall bullish trend but within it can be bearish trends with smaller time frames such as the one-hour or 15-minute time frames of an asset. Trends are therefore timeframe specific. This accounts for the different correct biases among traders trading the same asset. Whilst one trader is bullish biased, the other may be bearish biased.
This is workable depending on the strategy and time frame they are using. Swing traders and scalpers will surely have different biases as well. Doing multi-timeframe analysis is therefore of utmost importance to traders especially if they seek to have a full understanding of the market vis a vis a specific asset.
The identification of the trend of a currency is key to trading it effectively. Many traders identify trends by pure price action. They study the information and patterns exhibited by candlesticks. Some traders also use indicators to help them identify these trends adequately. The various trend-identifying indicators and their uses are what this article seeks to unravel.
The Moving Averages
The Moving Average is an indicator used as a technical analysis tool that is constantly updated by calculating the average price movements according to a specific period. A moving average is a line that puts price fluctuations in perspective on a chart.
There are two kinds of Moving average: the Simple Moving Average (SMA) and the Exponential Moving Average (EMA).
- The Simple Moving Average
The simple moving average (SMA) calculates the arithmetic mean of a given set of past prices of an asset over a specific period to present a trend line. It is an indicator used to identify the direction of the trend without the influence of current price movements or spikes.
It’s calculated over periods such as 10 days, 50 days, 100 days, 200 days, etc. However, traders prefer using the 50-day, 100- day and 200-day SMAs. The angle of the moving average is used to determine the trend of the market. An upward angle in the moving average line is indicative of an uptrend. Nevertheless, this does not predict what would happen in the future of an asset. The SMAs are used to ascertain buy and sell opportunities when and where different moving averages intersect. The SMAs are also used as support and resistance to the price when the price is unable to break the SMA line.
- Exponential Moving Average
The exponential moving average (EMA) is a weighted average that is affected by the recent prices of an asset. It is therefore an indicator that is more responsive to recent data and the new information posed by the market. Though the EMA is different from the SMA, the EMA is calculated after the simple moving average (SMA) over a particular period is first calculated. The EMAs are also used to determine support and resistant areas. They provide signals for buying and selling when some specific EMAs intersect. The most popular EMAs used by most traders are the 5 EMA, 13 EMA, 50 EMA, 200 EMA, 800 EMA, 3200 EMA.
Moving Average Convergence Divergence (MACD)
The Moving Average Convergence Divergence (MACD) is a very important oscillating indicator used by a number of beginners and advanced traders. The MACD indicator is made up of two major lines. They are the fast line and the slow line. It is used to determine to ascertain the price trend of an asset in the forex market. Trends are identified by observing whether the MACD lines are above or below the zero mark on the histogram situated below the chart.
When the MACD lines are consistently above zero, an upward trend in the asset price is ascertained. On the other hand, when the MACD lines are consistently found below the zero mark, it suggests a downward trend. It can also be used for buy and sell signals. Buy signals are indicated when the MACD lines move above the zero mark and the sell signals are indicated when the MACD lines move below the zero mark.
Also, buy and sell signals are indicated by the signal line crossovers. A buy signal is ascertained when the fast line crosses above the slow line. Sell signals are indicated when the fast line crosses below the slow line.
Since a table doesn’t stand on one leg, most traders do not use the MACD alone for the confirmation of trends. They usually combine MACD with support and resistance levels indicated by candlestick charts.
Relative Strength Index (RSI)
Another very important indicator used by most traders is the Relative Strength Index (RSI). The RSI is also an oscillating indicator that determines the momentum of price movements.
The Moving Average Convergence Divergence (MACD) though an oscillating indicator provides less information as compared to the RSI. The Relative Strength Index is confined between the zero and the 100 mark being the reason it is said to provide different information than the MACD.
An uptrend of the price of a currency is determined when it reaches 70 and above for a long period of time. Downtrends are also determined when the price is consistently below the 30 mark. The users of RSI use words like overbought and oversold areas. An asset is considered to be overbought when the price reaches the region between 70 and 100 on the RSI. An asset is said to be oversold when the RSI lines are below the 30 mark.
The RSI is also used to ascertain that a trend is yet to be exhausted, allowing traders to enter more positions until the trend is finally exhausted. When a strong trend gets to between 55 to 60 marks, traders are able to capitalize on the few moves whilst knowing that the end of the trend or corrections are imminent. With this in mind, traders may set shorter take profits depending on their strategies to prevent losing their profitable trades.
On-Balance Volume (OBV)
The On-Balance Volume (OBV) indicator is another significant technical analysis indicator used by a variety of forex traders. It was made known by Joseph Granville in the 1960s. It was originally designed for the stock market, but it has become popular among forex traders as well because of its usefulness. It measures the volume of an asset and presents it as a single line daily. Volume is an important indicator in trading since it determines the buying and selling pressure cumulatively.
It is displayed at the bottom of the trading chart. Being a leading indicator, a sharp move of the indicator indicates an upcoming buying pressure engineered by big traders.
It is used to confirm the trend of assets by volume measurement. When the price of a currency pair rises, the OBV also rises. The reverse is true in that when the price falls the OBV also falls.
