All types of market trends explained - Beginners Guide
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Many traders live by the often-repeated “the trend is your friend until the end” rule; they are comforted with the knowledge that they are with the majority of the market.
Being able to ride on a trend is akin to making full use of the wind direction to steer your ship towards your destination.For a ship to go against the wind requires a tremendous amount of effort – one has to fight the stubborn resistance from the opposing wind.
Indeed, for most of the time, it pays more to be on the side of the current trend than to go against it.
In the forex market, trend riders can capture any trend regardless of whether it is rising or falling in an attempt to generate trading profits. Forex tends to have quite trending markets, regardless of which time frame you are looking at – trends are often formed on hourly, daily or weekly charts. This is due to the fact that currency price movements are very much influenced by the underlying macroeconomic factors which in turn shape the market players’ views of where currency prices should be heading. With trends possibly having a long lifespan stretching to months, or even years, it is no wonder that many traders and fund managers exalt the strategy of hitching onto trends, with the glorious aim of capturing enormous profits from start to finish.
Trend riding is one of my favourite trading approaches, and I often ride the uptrend or downtrend after the trend has been established, rather than anticipating the move before it happens. I would say that even though the trend is your friend most of the times, one has to use a variety of methods to distinguish between a continuation of the trend and a possible trend reversal. But before you can ride on trends, you first need to identify what the current trend is, and to determine the time frame of the trend.
Sometimes, people ask me for my opinion on the current trend for certain currency pairs, I reply with another question in return, “According to the past 5 mins, 5 hours, 5 days or 5 weeks?” Some traders are not aware that different trends exist in different time frames. The question of what kind of trend is in place cannot be separated from the time frame that a trend is in. Trends are, after all, used to determine the relative direction of prices in a market over different time periods.
1. Primary trend
Aprimary trend lasts the longest period of time, and its lifespan may range between eight months and two years. This is the major trend that can be spotted easily on longer term charts such as the daily, weekly or monthly charts. Long-term traders who trade according to the primary trend are the most concerned about the fundamental picture of the currency pairs that they are trading, since fundamental factors will provide these traders with an idea of supply and demand on a bigger scale.
2. Intermediate trend
Within a primary trend, there will be counter-cyclical trends, and such price movements form the intermediate trend. This type of trend could last from a month to as long as eight months. Knowing what the intermediate trend is of great importance to the position trader who tends to hold positions for several weeks or months at one go.
3. Short-term trend
A short-term trend can last for a few days to as long as a month. It appears during the course of the intermediate trend due to global capital flows reacting to daily economic news and political situations. Day traders are concerned with spotting and identifying short-term trends and as such short-term price movements are aplenty in the currency market, and can provide significant profit opportunities within a very short period of time.
No matter which time frame you may trade, it is vital to monitor and identify the primary trend, the intermediate trend, and the short-term trend for a better overall picture of the trend.
In order to adopt the Trend Riding Strategy, you must first identify a trend 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.
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 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. For the Trend Riding Strategy, I shall focus only on the uptrend and the downtrend.
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.
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.
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.
Being able to ride on a trend is akin to making full use of the wind direction to steer your ship towards your destination.For a ship to go against the wind requires a tremendous amount of effort – one has to fight the stubborn resistance from the opposing wind.
Indeed, for most of the time, it pays more to be on the side of the current trend than to go against it.
In the forex market, trend riders can capture any trend regardless of whether it is rising or falling in an attempt to generate trading profits. Forex tends to have quite trending markets, regardless of which time frame you are looking at – trends are often formed on hourly, daily or weekly charts. This is due to the fact that currency price movements are very much influenced by the underlying macroeconomic factors which in turn shape the market players’ views of where currency prices should be heading. With trends possibly having a long lifespan stretching to months, or even years, it is no wonder that many traders and fund managers exalt the strategy of hitching onto trends, with the glorious aim of capturing enormous profits from start to finish.
Trend riding is one of my favourite trading approaches, and I often ride the uptrend or downtrend after the trend has been established, rather than anticipating the move before it happens. I would say that even though the trend is your friend most of the times, one has to use a variety of methods to distinguish between a continuation of the trend and a possible trend reversal. But before you can ride on trends, you first need to identify what the current trend is, and to determine the time frame of the trend.
TIME FRAMES OF TRENDS
Sometimes, people ask me for my opinion on the current trend for certain currency pairs, I reply with another question in return, “According to the past 5 mins, 5 hours, 5 days or 5 weeks?” Some traders are not aware that different trends exist in different time frames. The question of what kind of trend is in place cannot be separated from the time frame that a trend is in. Trends are, after all, used to determine the relative direction of prices in a market over different time periods.
There are mainly three types of trends in terms of time measurement:
- 1. primary (long-term),
- 2. intermediate (medium-term), and
- 3. short-term.
1. Primary trend
Aprimary trend lasts the longest period of time, and its lifespan may range between eight months and two years. This is the major trend that can be spotted easily on longer term charts such as the daily, weekly or monthly charts. Long-term traders who trade according to the primary trend are the most concerned about the fundamental picture of the currency pairs that they are trading, since fundamental factors will provide these traders with an idea of supply and demand on a bigger scale.
2. Intermediate trend
Within a primary trend, there will be counter-cyclical trends, and such price movements form the intermediate trend. This type of trend could last from a month to as long as eight months. Knowing what the intermediate trend is of great importance to the position trader who tends to hold positions for several weeks or months at one go.
3. Short-term trend
A short-term trend can last for a few days to as long as a month. It appears during the course of the intermediate trend due to global capital flows reacting to daily economic news and political situations. Day traders are concerned with spotting and identifying short-term trends and as such short-term price movements are aplenty in the currency market, and can provide significant profit opportunities within a very short period of time.
No matter which time frame you may trade, it is vital to monitor and identify the primary trend, the intermediate trend, and the short-term trend for a better overall picture of the trend.
TREND DIRECTIONS
In order to adopt the Trend Riding Strategy, you must first identify a trend 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 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. For the Trend Riding Strategy, I shall focus only on the uptrend and the downtrend.
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.
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.
About Kuldeep Nikam
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