 |
|
Take a quick tour of Interbankgroup.com's features and learn how
Interbankgroup.com
can help you trade with success.
 |
|
|
|
|
Using
Indicators to Identify Trends
Of the many market sayings thrown around by traders, perhaps
none is more overused and less understood than the old
adage 'the trend is your friend'. All too often, the phrase
is used after a trader has taken a counter-trend position
and subsequently been stopped out at a loss. Remorse sets
in at this point and most traders kick themselves not
only for having lost on a counter-trend trade, but also
for not having caught the latest move in the trend itself.
To avoid this all too common scenario, we will suggest
using several technical tools to identify whether or not
a trend is in place and then use additional indicators
to help maximize trading profits. Having a strategy in
place to identify trends is essential to successful trading
in any market, but especially so in the case of the forex
markets. Currencies have a greater tendency to move in
trending fashion due to the longer-term macroeconomic
elements that drive exchange rates, such as interest rate
cycles or global trade imbalances. Currencies are also
pre-disposed to short-term, intra-day trends due to international
capital flows reacting in unison to day-to-day economic
and political news.
Identifying the Trend
In its most basic sense, a trend is simply a prolonged
market movement in one general direction, either up or
down. From a traders' perspective, though, that simple
definition is so broad as to be relatively meaningless.
A more relevant definition of a trend would be one where
a trend is defined as a predictable price response at
levels of support/resistance that change over time. For
example, in an uptrend the defining feature is that prices
rebound when they near support levels, ultimately establishing
new highs. In a downtrend, the opposite is true-price
increases will reverse as they near resistance levels,
and new lows will be reached. This definition reveals
the first of the tools used to identify whether a trend
is in place or not-trendline analysis to establish support
and resistance levels.
Trendline analysis is often underestimated because it
is perceived as overly subjective and retrospective in
nature. While both criticisms have some truth, they overlook
the reality that trendlines help focus attention on the
underlying price pattern, filtering out the noise of the
market. For this reason, trendline analysis should be
the first step in determining the existence of a trend.
If trendline analysis does not reveal a discernible trend,
it's probably because there isn't one.
Trendline analysis is best employed starting with longer
timeframes (daily or weekly charts) first and then carrying
them forward into shorter timeframes (hourly or 4-hourly)
where shorter-term levels of support and resistance can
then be identified. This approach has the advantage of
highlighting the most significant levels of support/resistance
first and less important levels next. This helps reduce
the chances of following a short-term trendline break
while a major long-term level is lurking nearby.
Another technical tool that can be deployed to verify
the existence of a trend is the directional movement indicator
system (DMI), developed by J. Welles Wilder (see Wilder,
New Concepts in Technical Trading Systems, c. 1978). Using
the DMI removes the guesswork involved with spotting trends
and can also provide confirmation of trends identified
by trendline analysis. The DMI system is comprised of
the ADX (average directional movement index) and the DI+
and DI- lines. The ADX is used to determine whether or
not a market is trending (regardless if it's up or down),
with a reading over 25 indicating a trending market and
a reading below 20 indicating no trend. The ADX is also
a measure of the strength of a trend--the higher the ADX,
the stronger the trend. Using the ADX, traders can determine
whether or not there is a trend and thus whether or not
to use a trend following system.
As its name would suggest, the DMI system is best employed
using both components. The DI+ and DI- lines are used
as trade entry signals. A buy signal is generated when
the DI+ line crosses up through the DI- line; a sell signal
is generated when the DI- line crosses up through the
DI+ line. (Wilder suggests using the "extreme point
rule" to govern the DI+/DI- crossover signal. The
rule states that when the DI+/- lines cross, traders should
note the extreme point for that period in the direction
of the crossover (the high if DI+ crosses up over DI-;
the low if DI- crosses up over DI+). Only if that extreme
point is breached in the subsequent period is a trade
signal confirmed.
The ADX can then be used as an early indicator of the
end/pause in a trend. When the ADX begins to move lower
from its highest level, the trend is either pausing or
ending, signaling it is time to exit the current position
and wait for a fresh signal from the DI+/DI- crossover.
Continued |
|
 |
|
|
 |
| Unfamiliar with forex trading? Visit InterBank
Group's Learning Center
for a wealth of information about the forex market. |
 |
Basics
Great if you're new to the foreign exchange
market. |
 |
Pro
A look at sophisticated forex trading strategies and
methods. |
|
|
 |
|
| |
|
 |
|
