Friday, March 13, 2009

How to Spot a Trend in the Spot Forex Market

By Sean Hyman Traders and investors alike love to talk about trends – particularly in currencies. Analysts are constantly trying to determine where particular currencies are trending this hour, this day, this week, in the next few months, etc.

Of course, they’re hoping to catch a trend on the way up (or down) and cash in on a particular currency pair.

And frankly, it works. In fact, one of the easiest ways to earn consistent profits in any market is follow the trends. For example, so far this year, the dollar has been on an absolute tear against many emerging market currencies like the Hungarian forint, South African rand and Turkish lira. I have a couple exotic trader friends who have made a killing this year already (I’m talking up over 700% on a single trade), just by pairing the strong dollar with the weak exotic currencies in the Forex market. (I want to link to EFX abovehere)

But I digress. Before you can ride a trend to double or triple-digit profits in Forex, you have to know how to recognize a trend. So let’s get back to the basics…how do you spot such a trend in the Forex market?

Well, one easy way to describe it is by recognizing what is NOT a trend. For starters, it is NOT a currency that’s trading in a sideways range (sideways range means that it’s a flat horizontal line on the chart). So if the pair you’re watching seems to be going nowhere, then it probably is in a sideways range and doesn’t count as a definable trend.

To figure out if it’s in a sideways range, look at the far left of the chart, where the price starts and then look to the right of the chart to see where the price is now. Did it go basically from the lower left of the chart to the upper right? If so, you have an uptrend.

Did the trend line move from the upper right of the chart down to the lower left of the chart? If so, you have a downtrend. Or in other words, look at the direction of the trend line (pretty basic).

Another way to define a trend is by watching theits major low and high points that it makes. An uptrend has “higher lows and higher highs.” Check out the USD/JPY Hourly, 30-Day chart below and you will see an example of an overall uptrend.

A downtrend has “lower lows and lower highs.” So it’s just the opposite of the uptrend.

Trends: The Short & Long of It

Many times, I’m asked what a long-term trend is and what’s a short-term trend? Well, while this is definitely debatable…let me tell you some ways to address this.

For most traders, a long-term trend is the one that they see on a daily chart that goes back a year or so. (Remember, a daily chart means that each candle covers a full 24-hour period of trading.)

Most traders define a short-term trend by looking at an hourly chart going back 20 to 40 days. Do realize though that if someone is an “intra-day” trader, then they may only look at a 15-minute chart that stretches out over a couple of days. So it’s all really relative to the timeframes in which you trade.

However, I will say that while some investors long to become day traders (who truly place several trades a day), most individuals are better suited to become swing traders.

Swing traders place trades over days and not just hours or minutes. The reason? Every investment needs time to go up in value (or down in value, depending on your directional play) and the day trader doesn’t have time working in their favor.

In fact, usually you can only day trade after you’ve become successful at spotting long-term trends.

Let the Short & Long-Term Moving Averages Point the Way!

Also, here’s another way to define trends on any timeframe of chart. If you plot a 200 simple moving average on your chart, that will track the long-term direction for the time frame that you are presently on at the time.

A 20 simple moving average tracks the shorter-term direction of the pair at the time.

See the daily, 1-year chart of USD/JPY (below) for instance. Some people will look at that pair and say, “It’s in a downtrend.” Others will say, “No, it’s in an uptrend.”

Well both could be right DEPENDING upon what timeframes they are discussing. For instance, in the above chart, the longer-term trend over the course of the past year has been downward overall. So if the long-term is your focus, then the correct answer is “down.”

However, if you are looking at the recent activity over the past couple of months, then that latest activity is in a definite uptrend. However, that’s in the shorter (near) term. So the short-term trend is “up” and the long-term trend is still “down.”

Once the pair breaks and holds back above its 200 simple moving average (SMA) and the SMA starts to turn upward, then you can say we are in a long-term uptrend at that point typically.

So just to recap: 1. Look at the far left and right of the chart. Is it going up overall, down overall or just sideways? This is one way to tell the trend.

2. The other easy way to tell the trend is to use a 20 and 200 simple moving averages (SMA) on your chart. Look to see the slope of the line and which direction it’s headed in and you have your trend direction.

Trading note: Your highest probability trades are when the short and long-term trends are running in the same direction. So if your 200 SMA is pointing upward, it’s perhaps better to wait for the 20 SMA to climb above the 200 SMA and heads higher before placing your buy order.

Remember, that you can use these averages on any timeframe: 15 minute, one hour, four hour, daily charts, etc. The moving average will tell you what direction the pair is heading in for the timeframe you prefer to trade.

I’ll be back next week with more Forex trading tips and insider ideas. Until then…

Have a great weekend,
Sean

P.S. There’s no arguing it’s been absolute murder out there for stocks, commodities… well, just about everything this year. But as I said, a few Forex traders are cashing in on the global crisis by shorting emerging market currencies. Click here to find out how you can take advantage of one of the few identifiable trends in Forex this year.