Forex Trading Tip #4: How To Read Trend

How To Read Trend

How To Read Trend In The Forex Markets

There are many ways to make money out of the forex markets, but there are a handful of specific skills you must master in order to be a consistently profitable technical trader.

One of them is how to properly and consistently read the trend in forex markets.

This is a tricky one, because all traders must master it – yet most traders have a different opinion on what constitutes a trend.

Well, today I’m going to cut through all the nonsense and show you an extremely simple method that works extremely well. If you take the time to understand this concept, I promise that you will never be confused about a market’s trend ever again.

In fact, if you were previously unaware of this method, then you might find your ability to predict market direction accurately increases dramatically once you implement this into your trading.


The Four States of the Market

The markets can essentially be in one of four states:

  • A bullish trend
  • A bearish trend
  • A consolidation period
  • A reversal situation

It cannot be in more than one of these states at the same time, and one phase typically leads to another phase (ie. a bullish trend leads to consolidation, and consolidation may lead to reversal, and a reversal may lead to a bearish trend).

This makes defining what a trend really is very difficult for most traders.

If you were to put 1,000 unprofitable forex traders in a room and asked them how they read trend, all of them would have slightly different answers.

But if you were to put 1,000 profitable forex traders in a room and asked them the same question you would get a much more concise description from them. That’s because there is an infinite number of ways to interpret a trend, but only a handful that actually work.

Today I am going to show you ONE of the methods that work. There are a few others that I probably don’t know about, but this one has worked for me for the past three years and it has worked for my trading mentor throughout his entire career.


How To Objectively Define A Trending Market

There’s a lot of noise in the markets.

In fact, most of the price action in most markets is noise or consolidation with no clear directional bias. This makes capturing large trending moves consistently extremely difficult for most traders.

What do you see when you look at this chart?

Which Way Is This Market Headed Next?

Can you predict which direction it is more likely to head in by just glancing at it? If you can, then you probably don’t need to read this article. But if you can’t… then I’m about to let you in on a secret.

This is how I (and many professional traders) interpret this chart:

How To Objectively Contextualize The Trend

The black lines represent the trend. The red line represents the last line of defence for this bearish trend, and the blue line represents support for this consolidation period.

So long as price remains below that red line, the trend is bearish, and price is about 60-70% more likely to break out to the downside than it is to the upside. The accuracy varies, but it’s typically always above 50% no matter what market you’re using it on – so there is a definite edge to this method of trend analysis.

Therefore, in a situation like this – your overall bias should always be bearish, no matter what’s happening between that red and blue line!

That’s not to say that you can’t take long trades or try to capture swings or advanced patterns within this range of consolidation. But you should be aware that this market is likely to head lower from here before it breaks above the red line. Which means that any long trades you take should be considered counter-trend trades (and managed accordingly).


Objective Rules For Determining Trend

Even though these are cherry-picked examples for demonstration purposes, I would treat a live chart exactly the same way every time I perform my analysis and I always feel confident in the probabilities of being correct in my directional bias.

This is because I have objective rules for applying this method of reading trend.

The rules are very simple, and they go as follows:

Bearish Trend

  • The market must make a low
  • The market must then pull back by at least 2 green candles
  • At least one of those 2 candles must touch the 0.382% Fibonacci retracement level
  • The market must then make a new low
  • The highest high preceding the new low is our red resistance line
  • The lowest low of the current pullback is our blue support line
  • Until price breaks and closes above the red line, price is more likely to break and close below the blue line

Step 1: Identify Key Levels

Example Of A Bearish Trend With Fibonacci Retracement Filter

Step 2: Wait For Trend-Continuation

Step 3: Repeat Step 1

Rinse And Repeat Until The Trend Reverses!

Final Outcome

Example of What Happened Next

Can you guess where price went after this screenshot? You guessed it – below 117.534.

Summary

Final Example of Bearish Trend Analysis

Each time a new low is created, we draw a red line from the highest wick preceding the break lower.

Until price breaks and closes above that previous swing high, the bearish trend is to be considered intact, and price is to be expected to have a higher probability of continuing lower until one of these red lines is breached.

Once that happens, the trend is over. We then enter either consolidation or a reversal situation. Those two market conditions require their own article, so I’ll leave them out of this for now.



Bullish Trend

  • The market must make a high
  • The market must then pull back by at least 2 red candles
  • At least one of those 2 candles must touch the 0.382% Fibonacci retracement level
  • The market must then make a new high
  • The lowest low preceding the new high is our blue support line
  • The highest high of the current pullback is our red resistance line
  • Until price breaks and closes below the blue line, price is more likely to break and close above the red line

Step 1: Identify Key Levels

Example Of A Bullish Trend With Fibonacci Retracement Filter

Step 2: Wait For Trend-Continuation

Example Of Bullish Trend-Continuation

Step 3: Repeat Step 1

Rinse And Repeat Until The Trend Reverses!

Final Outcome

Example of What Happened Next

Where do you think price is likely to go next – above the red line, or below the blue line?

If you said above the red line, you’re a winner!

Example Of Trend-Continuation After Retest Of Support

Notice in this example that price did not close below 1.63, which was the blue line we drew in after price broke out to a new high.

The wicks tested below that level, but the candles did not close below there. Which means that throughout this entire period, our bias should have been bullish.

Summary

Final Example of Bullish Trend Analysis

Each time a new high is created, we draw a blue line from the lowest wick preceding the break higher.

Until price breaks and closes below that previous swing low, the bullish trend is to be considered intact, and price is to be expected to have a higher probability of continuing higher until one of these blue lines is breached.

Once that happens, the bullish trend is over. We then enter either consolidation or a reversal situation.

Conclusion

This method of analyzing trending markets is extremely simple yet extremely effective.

In my experience, it appears to work on all markets I’ve used it on – but it definitely works on most forex pairs, stock markets and cryptocurrencies.

The purpose of having objective and clearly defined rules for identifying a trending market is so that we can make the best decision on what strategies to employ at any given time.

Personally, I am currently a trend-continuation trader, which means I don’t want to be using my strategy when trend-continuation is unlikely to occur. Which means that I depend on this trend analysis in order to filter out low-probability setups.

The 0.382% Fibonacci rule is to make sure that we are only including major pullbacks in our trend analysis. We don’t want to count every single little 2 candle move as a trending move or else this method loses its accuracy. The purpose of this method is to identify the larger trend swings in a market.

Once you have mastered this skill, you can then employ intraday trading strategies to try to capture profit out of these predictable swings.

If you have any questions, feel free to leave a comment below and I will do my best to clarify any confusion you might have. Otherwise, I’ll leave you with this YouTube video by my trading mentor Steven Hart in which he demonstrates how to use this method:


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