Forex Trading: Analysing the Market Environment Part 2

What is a trending market?

When a price is mostly moving in one direction – up or down – over a given period of time, you would say that the market is trending in that direction.

Of course, you will get a few reversals as traders lock in profits, but looking at longer time frames, these would be seen as minor interruptions to the prevailing trend.

In an uptrend, the highs get higher, and so do the lows - as in this chart

In an uptrend, the highs get higher, and so do the lows – as in this chart

One way to define a trend is in terms of uptrends having higher highs and higher lows, and downtrends having lower highs and lower lows.

As a rule, trend-based strategies are a lot more effective when the market has a high degree of liquidity. This is why most traders that use these strategies tend to do so with major currency pairs and other pairs involving the US dollar, as these tend to be the most liquid.

The reason for this is that the more liquidity there is in a market, the more volatile it is likely to be. The more it moves, the greater the chance is that the price will begin to move strongly in one direction – or trend – rather than fluctuate between small ranges.

As well as taking a look at the price action itself for signs that the market is trending – always an important step – you can also make use of a range of technical tools to check whether a pair is trending or not.

Trend Detector No. 1: ADX

ADX-25-trending-forexthink

One effective method for determining if the market is trending is by using an Average Directional Index indicator (ADX).

This is an indicator with a range of values between 0 and 100 to show if price is trending or simply ranging. Numbers above the 25 mark usually suggest that the price is already involved in quite a strong trend. The higher the number, the stronger the trend.

It’s worth noting here that ADX is a lagging indicator. That means it is reflecting recent price action, which may or may not be a reliable indicator of future price direction. Also, it won’t tell you if the price is trending up or down – only the strength of the trend that it has detected.