Learn to use the Ultimate Trend Indicator in Forex... Your Eyes

Using Your Ultimate Forex Trend Indicator

Beginners tend to look for quick solutions to everything, and we often find that many beginners look for an easy shortcut to identifying a trend in the Forex market -- be it with an indicator or an automated "Expert Advisor" in MetaTrader.

Here's the problem: You're trying to learn how to drive a race car professionally, and even looking for ways to get a next generation robot to drive it for you, before you even understand how to turn a steering wheel.

Before you trade any strategy in any financial market, learn to see this very basic picture:

Now, that's all well and good for the text books, but that's not always the kinds of trends we see. So rather than cherry picking the very best, and clearest, trends to demonstrate this concept, take a look at a much messier picture:

It says to you, "In the past five hours, the buyers have been eating up most of the sell orders placed in the interbank market." Why? Take notice of the fact that despite the overall sideways look of this picture, the lows (A, B, C, D) are still in a progressively upward angle and the highs (X, Y, Z) are also at an overall upward angle to each other. In other words, the highs and lows may have been broken on both ends (so there isn't a real, clean, "higher highs and higher lows" type of trend) but the overall pressure is still coming from the buyers eating up the sell (and short sell) orders.

The bigger issue for traders, of course, is not only being able to see these trending periods clearly, but also knowing when to be more confident that a trend like this might actually continue in the same direction. Or so most beginners think.

As with the irony of our web site's name, we don't believe that it's generally a good idea to try to predict whether a strong trend will continue or reverse within the next few candles or bars. In a strong trend (a clean "higher highs and higher lows" uptrend or a clean "lower highs and lower lows" down trend), it's traditionally recommended that you "trade with the trend". However, the disadvantage of this advice is that you risk catching the very end of a strong trending move (chasing the trend) and end up being the last one holding the bag when everyone else has gone in the opposite direction -- leaving you in a deep loss that may not be recoverable, depending on how much of an extreme this trend happened outside of the typical range.

Also keep in mind that many of the "trend following" strategies in Forex originated from stock traders who use technical analysis and volume to filter for stocks that might be unusually strong or weak on a particular day. They do this by looking for stocks that have moved a significant amount (strong up or down trend) coinciding with unusual volume. There's two problems with this technique in trading Forex.

Firstly, there is no single reliable source of volume data in the Forex market no matter what anyone tells you. (Yes, there is tick data, and some sources provide more of it from more sources than others, so it can look very similar to volume analysis in stocks, but it's still not the same thing.) The fact is that a sudden move in a currency pair in any direction (up or down) together with a giant spike in tick volume is not the same as Company X's stocks suddenly flying upward at 2x Average Daily Volume within the first hour of NYSE trading. In Forex, it's much more likely that the move was caused by an economic news release (especially the US non-farm payroll report on the first Friday of every month) or one of the regional session openings (especially London and New York), and neither of these reasons tend to signal that the market will continue to move in that direction indefinitely.

With the exception of a major economic crisis (which, fortunately, does not happen on a daily basis and is therefore not an event that day traders should expect to trade on a daily basis) it's actually very unlikely that such a move would cause the market to remain one-sided for the rest of the day. Moreso than any other market, retracements are a fact of life in Forex, so make them your friend rather than an annoying thorn in your side.

The consensus among our team is that the much safer method of trading a trend in Forex, is to look for potential turning points. This is not necessarily a counter trend strategy; keep in mind that during an uptrend, many retracements occur and those retracements are mini-down trends (lower highs and lower lows). The same is true of down trends in Forex, where despite the overall selling pressure in the market, there are retracements that are mini-up trends (higher lows and higher highs). To trade the first turning point after these retracements is actually a with-the-trend trading strategy.

Here's the most basic way to find these "first turning points":

This is an hourly chart, and yes, these really happen. (You don't necessarily need to wait for these to happen before placing a trade, but these are good setups so you might want to allocate larger sizes to these trades than, say, a muddy looking trend.) Now, seeing that nice, clean, up trend on the above chart, especially at times like 13:00 (1 PM) in UK local time (ie. GMT, or BST in the summer) when the American banks are getting ready to enter the market, it would be a good time to watch for that first failure to break a higher high, and wait for the first break into a lower low (the first sign of a possible trend reversal.)

If you plan to trade pure first-break setups like this, remember that this pattern (A to B in this example) may actually be an upward retracement during a bigger downtrend. Or it might actually be part of a very strong up trend. The only way to know for sure is to zoom out on your chart (or move up to a higher time frame like 4-Hour or Daily) to take a look at the bigger picture. In either case, this setup should be tradeable as long as you keep your risk tight. The most obvious place to set a stop-loss order for the basic first-break trade is right outside of the last swing (in this example, right at the top of B, maybe with about 5 to 10 pips outside of it depending on the time frame you're seeing this pattern in.)

Always remember that inside of every big uptrend in a daily time frame, there are a bunch of small down trends (and up trends too) in the hourly time frame. The same can be said between an hourly and a five-minute time frame, and so on. There is no single correct identification of trend -- it depends on your trading style. If you're a day trader, it's not practical to worry about the monthly trends. Likewise, if you're a long-term position trader, you're wasting your time worrying about every new trend in five-minute candle charts because it would have turned a few hundred times during your trade and none of those little turns should affect the execution of your trading plan.

Lastly, why waste time and money trying to get a computer to do your eyes' job. If you want to be a trader, and not a computer technician with a dream, then learn and internalize these basic principles of identifying a trend in the Forex market. With enough practice, you should be able to take a brief glance at a chart, in any time frame, and see the current trend without a moment of hesitation. That's worth more than a thousand robots and fancy indicators.

Also be sure to take a look at our Forex Fibonacci trading strategy for another way to trade this sort of price action at the peak of a strong trending move.