How to Find and Trade Forex Trends

Huzefa Hamid

In case you missed this week’s webinar or want a recap, here's what we've discussed about how to spot trends and trade them profitably.

Trends are powerful because they show institutional order flow and are the most profitable market condition for any trader. You must know how to recognize a trend so you can be on the right side of the move.

In this webinar, we breakdown the anatomy of a trend and look at specific keys to find entries when a trend unfolds.

Key Takeaways

1. The definition of an uptrend is a series of higher lows. Conversely, a downtrend is a series of lower highs. You can draw neat trendlines on some trends, but a trendline isn't necessary to define a trend.

2. The move in the direction of the overall trend is called an "impulsive move." The move which pauses a trend is called the "corrective move." A corrective move can be horizontal or slightly against the direction of the impulsive move.

3. Impulsive moves have candles that consist mostly of the same color, close near the direction of the move, and contain the largest candles.

4. Corrective moves have a mix of candle colors, candles with longer wicks and shorter candles overall.

5. Support & resistance breaks and retests – such as when a support level is broken and subsequently retests a resistance level – can provide precise entry points into a trend.

6. Higher timeframe trends will dominate lower timeframe trends. If you're trading against the higher timeframe trend, be ready to take profits.

If you've ever traded Forex, you've probably heard people say, “find the trend, that's where the money is”, or “the trend is your friend”. While that's accurate, it's also a bit oversimplified. So let's give it a bit of context and discuss how to identify and trade trends.

 

Let's begin with understanding the anatomy of a trend:

Typically, when price moves from from point A to point B, it doesn't move in a straight line. It will zigzag its way between points, like so:

Uptrend higher lows

You know you're looking at an uptrend if you see higher lows, which is a defining characteristic of an uptrend. Some people might say an uptrend is defined by higher highs, but this is inaccurate. Higher lows means that the support levels are rising, which is more indicative of an upward trend. An easy, but slightly uncouth, way to remember this is one I heard from Forex guru Chris Manning years ago: when you're going up an escalator, you're looking at people's bottoms.

Conversely, when you descend an escalator, you're looking at the tops of people's heads, which is analogous to a downtrend: you know you're looking at a downtrend when you see lower highs, which means that resistance levels are going down:

Downtrend lower highs

An example of a downtrend can be seen on this 15-minute chart for the USD/JPY pair, where there are lower and lower highs:

USD/JPY 15 minute chart

You can see how the support level gets broken at the end, though this doesn't necessarily mean that the price is now in an uptrend; it simply means that that segment of the downtrend is exhausted. So if you're looking to short the pair, you'll want to wait until the downtrend re-establishes itself.

You can also use a trendline to show the angle and steepness of a trend, as shown here, though my personal preference remains to mark the lower highs:

USD/JPY 15 minute trendline

Let's break it down a bit more, starting with this simplified chart of an uptrend:

Uptrend impulsive corrective diagram

In any trend, you'll see moves that are congruent with the trend, and moves that are counter to the trend. Moves that are congruent with the trend are called impulsive moves, and moves that are counter to the trend are called corrective moves. You can see this in downtrends as well:

Downtrend impulsive corrective diagram

But how can you tell when the price is in the throes of an impulsive move in a trend? To answer this, we'll look at the three characteristics of an impulsive move:

  1. Candles in the impulsive section of a trend will be mostly the same color (around 80%).

  2. The candles mostly close in the direction of the move.

  3. The largest candles are within the trend of that impulsive move.

Let's look at an example of these, using the daily chart for the EUR/USD pair, where each candle represents a day:

EUR/USD daily chart

I've marked where the price rose from point A to point B, and it's evident where the impulsive moves are, because a) the candles are mostly the same color, b) the candles close in the direction of the move and c) the largest candles stay within the trend.

Now that we've discussed impulsive moves, here are the signs that you're looking at a corrective move:

  1. There is a mix of candle colors.

  2. The candles tend to have longer wicks, being more indecisive.

  3. The candles themselves tend to be shorter.

Looking at the same chart for the EUR/USD, I've marked a free arrow where there is a corrective move:

EUR/USD daily chart

Clearly, the candles are a mix of colors, the wicks are longer and the candles are shorter within the space.

Let's look at another example with a live trade I took, using the GBP/USD 15-minute chart:

GBP/USD 15 minute chart

Point A is where a large dose of volatility and order flow drove the price down. The rectangles show that the candles in that sequence mark an impulsive move, being almost all the same color. That was followed by a corrective move, with candles that are a mix of colors and sprout longer wicks. I entered the trade where I've marked the free arrow, predicting that another impulsive move was to follow, which it did.

As I mentioned above, the direction of a trend is defined by higher lows (for an uptrend) or lower highs (for a downtrend). In more technical terms, this means that an uptrend is marked by higher support levels, and a downtrend is marked by lower resistance levels.

When talking about support and resistance levels – especially as they pertain to trends – it's important to understand the concept of role reversal.

Role reversal is when support becomes resistance or vice-versa. This very simplified diagram shows the general idea:

Support & Resistance Role Reversal

Here, the resistance level was broken through, after which the price fell back down to test that same level as support.

Role reversals happen a lot in trends, and they allow you to find a place to jump in on a trend when they occur.

The market psychology behind a role reversal is simply that short traders drive the price up to the resistance level, and the point at which the resistance become support is where those traders are getting out of the trade and breaking even.

Looking at the daily chart for gold, we can see a more concrete example of a role reversal:

Gold daily chart

It's not very neat, but you can see how the yellow support line was broken and then tested as a support level.

This second, lower support line was broken with an impulsive move, then made a corrective move to twice test the support level as resistance:

Gold Daily chart

The four-hour chart for the GBP/USD is another example:

GBP/USD 4 hour chart

The price has been trending up, marked by the higher lows, and points A and B are where the price touched the level as resistance. Then, it broke through that resistance and came back to close right at the same level, as support, which would have been a good buying level.

The 15-minute chart gives us a closer look:

GBP/USD 15 minute chart

The ascending higher lows show the uptrend, where the price made a clear impulsive move to break through the resistance. The points we mentioned earlier, where the price touched that level quite neatly, marking it as support, would have been a good buying entry.

Here, the AUD/USD chart also shows us an instance of role reversal within a trend:

AUD/USD four hour chart

The higher lows form an uptrend, which then touches the resistance level. The pair then made a strong impulsive move to break through that level, and after a corrective move, came back down to test the area as support.

An important rule of thumb to remember about trends is that higher timeframes dominate lower timeframes. That means that if you're looking at a short-term chart, like the hourly, which is showing the price trending in a certain direction, and you're looking at a long-term chart, like the daily, which is showing the opposite direction, the daily chart will often be the one showing the correct general trend. The best trades, of course, are when the short-term and long-term charts are in congruence.

In general, I define lower timeframes as the one-hour, the 15-minute, and the five-minute charts, and higher timeframes as the weekly, daily and four-hour charts. I use the higher timeframes for my analysis, and the lower timeframes for my execution of a trade.

A great resource I recommend is Eightcap.com's article on using moving averages and RSI indicators to capture trends, which you can find by going to Eightcap's website, clicking on “Learn” and then on “Trading education overview”. For clarity's sake, it looks like this:

Eightcap Trading 101

Another resource is FXacademy.com, which also has some informative articles on trends.

Here are some of my final thoughts:

If you find that a chart isn't clear enough, stay away from it. Either use a different timeframe, or trade a different pair.

Also, make sure to always mind your risk. Use stop losses, positive risk/reward ratios, targets that are higher than your stop losses, and other basic risk management methods, so that you trade as safely as possible.

Huzefa Hamid

I’m a trader and manage my own capital. I trade the major Forex pairs, some Futures contracts, and I rely entirely on Technical Analysis to place my trades. Today, I am also a Senior Analyst for DailyForex.com. I began trading the markets in the early 1990s, at the age of sixteen. I had a few hundred British pounds saved up (I grew up in England), with which I was able to open a small account with some help from my Dad. I started my trading journey by buying UK equities that I had read about in the business sections of newspapers. The 1990s were a bull market, so naturally, I made money. I was fortunate enough in my early twenties to have a friend that recommended a Technical Analysis course run by a British trader who emphasized raw chart analysis without indicators. Having this first-principles approach to charts influences how I trade to this day.

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