One of the reasons investors are attracted to the Forex market is because of trends. Everyone wants to ride a trend, and the currency market offers equal chances for both bulls and bears. The principles of a bullish trend are similar to the ones of a bearish trend. The only important difference is, that in a bullish trend investors are looking to buy, while in a bearish trend they are looking to sell. Having said that, we first need to define what a trend is, and what a trendline is. You’ll see that despite general belief trends don’t form that often, not even in the FX market which is considered the most liquid financial market in the world.
When currency investors refer to “a market,” they mean a currency pair. So, when the market (currency pair) trends, it means it falls or rises for some time. Don’t expect to see the market moving in a vertical line. Instead, a pattern exists, and this pattern gives investors an incentive to ride the trend.
Higher highs and lower lows
Even the most robust trend has its pullbacks. Hence, investors look for a series of events to characterize trends. In a bullish trend, the market forms a series of higher highs and higher lows. Namely, when the market advances, it makes new highs. And, when it declines, it fails to break the previous lows. A bearish trend, though, is characterized by the opposite: the market makes a series of lower lows and lower highs.
The chart above shows the recent USD/CAD price action on the daily timeframe. Any potential trend in this timeframe has a meaningful impact on an investor’s method. The highlighted area shows a bearish trend that follows the rules described earlier; the market forms a series of lower lows accompanied by lower highs. As a rule of thumb, the trend will continue as long as the series continues. Opposing it is a risky approach and some believe this should only occur when reversal patterns form.
What about a trendline?
As the name suggests, a trendline is the line of the trend. Investors look to draw the perfect trendline, but it is subject to chart settings and even server times that can affect the closing time of each candle. In any case, for a trendline all investors need are two points. No more, no less. The resulting line is the trendline, and the two points are:
- for a bullish trend – the bottom and the first higher low,
- for a bearish trend – the top and the first lower high.
If we apply this rule to the USD/CAD example we used earlier, we will end up with a bearish trendline, as follows:
Connecting the top with the first lower high gives the line of the trend. Before discussing what a trendline is used for, you should know that there is a myriad of ways to use it. One of them is to copy and paste it onto the previous trend’s lower high (the last trend was bullish). The resulting trendline is used as dynamic support for future trading decisions.
- Trends do not form that often.
- Focus on the series of higher highs and lower lows.
- Define the line of the trend.
- Use it to make a bullish or bearish case for future trade.