Forex trend lines
If you view a forex chart in a short time frame such as 5 mins; you will notice that the pattern is more like a zigzag as the prices go up and down with time. But, on higher timeframes, you are likely to notice that there the prices are generally going up or down. Forex trend refers to the overall direction of the price of the currency pair. Though the price action appears zigzag, it still follows an imaginary part in one direction.
An uptrend is identified if the prices keep going higher with higher highs and higher lows with time. A downtrend is when the prices keep making lower highs and lower lows. Sideways trend occurs when there is no market direction; it means that the number of sellers and buyers in the market are almost equal. Forex traders are always looking for a trend since they only make profits when they correctly predict the price direction. So, they use trend lines a lot.
Trend lines are straight lines that are drawn on forex charts to help identify the general direction of the exchange rates. It is drawn diagonally while touching a few support or resistance levels. Trend lines are drawn by joining the significant lows in an uptrend and connecting significant highs for a downtrend.
How to draw trend lines
To draw trend lines on the MT4 or other trading platforms, you will need two or more points in the chart. Pick the significant points and draw a line to join them. Observe the following rules while drawing trend lines:
Always start with higher time frames and gradually narrow it down to lower time frames. The longer the trend line, the better and more accurate it becomes.
Do not force a trend line to fit on the price points. If the trend line does not fit well, then the trend is not obvious; just abandon it and look elsewhere.
Ensure that your trend line touches as many candlesticks as possible. Avoid letting the trend line cut through the body of the candlesticks. As much as possible, let the trend lines connect the opening, closing, or wicks of the candlesticks.
A trend line that is pointing higher with a positive slope is an uptrend while a downtrend points down and has a negative slope. A stronger trend is steeper; that is, it makes a larger angle with the horizontal while a weaker trend is almost flat making a smaller angle with the horizontal.
Trend lines are simple to understand and easy to draw. But, trend lines are not always accurate, so, more analysis is required.
Moving Averages (MAs)
This is one of the technical indicators used to determine the direction of a trend. It is one of the popular indicators used in technical analysis of the forex market. It comes with most forex trading platforms. The indicator works by calculating the average of the latest data points in the price of the forex pair for the last ‘X’ periods. Then, it plots the graph and overlays it on the chat candlesticks. New averages are recalculated based on the latest closing prices within the time frame.
Trend lines are straight lines but ideally, market price movements are not straight, so Moving averages try to follow the random price movements so that you can clearly see the trend. In other words, it helps to smooth out the price action. When using MAs, you will have to select the type, period, and where to apply such as opening prices, closing prices, etc. If you include more periods, it means increased data points; which make the indicator more effective. But fewer or too many data periods will be less effective in detecting the trend. MAs do not predict the direction of prices but they are lagging indicators that can only be used to analyze previous prices.
Types of moving averages
Below are the most popular moving averages used by forex traders:
Simple moving average (SMA)
This is the mathematical mean of the recent data points plotted on the charts. For example; it can be computed by adding the last 5 closing prices of the forex pair and dividing the sum by 5. The averages keep moving as the points add. So, if it is on an hourly chart (H1), it will add the closing prices of the last 5 hours and divide by 5. Then, it continues adding more periods as the market progresses
The chart above shows 3 simple moving averages of 5, 25, and 60 periods. Notice that the 60 period SMA lags when compared to the smaller period SMAs. One problem with SMAs is when there is a sudden spike in price, it may give false signals.
Generally, an uptrend is identified when the chart price action is above the moving average and a downtrend is indicated when it is below the moving average. Moving average crossovers can help in identifying when a trend is ending or reversing. Traders usually overlay some moving averages with different periods on the chart and wait for a crossover. When two moving averages cross each other, it might be the signal that the trend is about to reverse.
Exponential Moving averages
This type of average gives more weight to the recent price points thereby making it more responsive to newer price changes. It is calculated as follows:
SMA is first calculated.
Multiplier = 2/(period +1)
Current EMA = (closing price – SMA of previous period) X (Multiplier + Previous SMA)
There is no need to do the calculations because it is automatically applied by the indicator. EMA is more sensitive to recent price data when compared to SMA. But, the SMA uses equal weighting on all available data.
This is a technical indicator that comprises 3 bands that are overlaid on the forex charts. It was developed by John Bollinger, hence the name; Bollinger bands. The middle band is a moving average while the upper and lower bands are standard deviations. All parameters are chosen by the trader at the point of using the indicator. Bollinger bands is a measure of volatility that measures the price of a forex pair in comparison with previous prices.
The bands widen with an increase in prices and narrow when prices reduce. From the position of the bands, a trader can attempt to predict the strength of a trend and how fast or slow the prices are moving. If the prices reach the upper band, it could mean that prices are rising and so, the trader can go long on the forex pair.
When the price rallies around the lower band, it could mean a strong downtrend especially if it stays well below the middle band.
Trend lines are used to determine the direction of the market. It is drawn by joining lower price points or higher price points depending on the direction of the trend. A steeper line means stronger trends. Moving averages are indicators used to determine the direction of the trend. Simple moving averages (SMAs) easily calculate the mean of the closing prices while Exponential moving averages (EMAs) focus on recent prices. Crossovers might mean that you should get ready for a change in market direction.
Bollinger bands is used to measure volatility using 3 bands; a middle SMA and 2 upper and lower standard deviation bands. Prices within the upper band indicate an uptrend while prices within the lower band indicate a downtrend.