Do you know that you can identify the forex market trend using the moving average? If you want to build your career in forex trading, you should have strong knowledge about trend identification as trend-following strategies are very profitable in the financial market.
If you don’t know how to identify the trend, there is good news for you. Because in the following section, we will guide you to trend identification methods using the moving average with in-depth techniques. After completing the whole section, you will be capable of predicting the price trend and find high-accuracy trades.
What is Forex Market Trend?
If you don’t know what forex market trend is, the following section is for you. Here you will see how we can define the forex market trend to find profitable trades.
Trending market and ranging market are standard terms in forex trading. In a trending market, the price moves upside or downside by creating new highs or lows.
In a bearish trend, the price of a currency pair moves down by creating lower lows, and sellers usually make a profit from it. In the image below, we can see an example of a downtrend market where lower swing points are marked.
On the other hand, In a bullish trend, the price of a currency pair moves higher by creating higher highs, and buyers usually make a profit from it. In the image below, we can see an example of the uptrend market where higher swing points are marked.
In these images, we can see that the price made an aggressive movement towards upside and downside, which effectively makes profits. However, traders often find it challenging to identify the forex market trend as it remains in a range most of the time.
There are many tools to predict the price trend, and moving average is one of them.
What is Moving Average?
Moving average is a forex trading indicator that shows the average price of the last number of candles. It moves with the price and shows in a dynamic line.
The basic idea about trend identification with the moving average is that the overall market trend is an uptrend when the price is above the moving average. Conversely, when the price moves below the moving average, the trend becomes bearish.
Therefore, the primary idea is to identify the price’s location based on the moving average and anticipate the future price direction.
Let’s have a look at a visual representation trend identification using the moving average.
In this image, the market trend is up when it was above the moving average. Later on, the price moved down below the moving average and initiated a downtrend.
Identify Forex Trend Using the Moving Average
In the above section, we have seen the basic trend finding techniques using the moving average, but there is more to know.
Every trend has two fundamental characteristics- impulse and correction. In this section, we will see the exact direction-finding procedure in both impulsive and corrective price structures.
Identify Impulsive Trend
In an impulse, the trending price is controlled by either buyers or sellers. Therefore, we may see a strong movement towards the downside or upside.
The impulsive trend starts after a correction or consolidation, which is an order-building phase of the market. Once orders are built, the market starts to move with an impulse.
The best way to pick the impulsive trend is to use the 20 Exponential Moving Average (EMA), where we should focus on how the price reacted after breaking out from it.
At first, you have to find the correction, and once the correction is over, the price will aggressively move above or below the 20 EMA, pointing to an impulsive pressure.
The above image shows that the price was within the range and moved below the moving average, indicating the beginning of a downtrend.
Identify Corrective Trend
To identify the corrective trend, we can also use the 20 Exponential Moving Average. In the impulsive trend, the price moves aggressively from a dynamic level. But the price will not move with the impulsive pressure in the long run. After an impulse, the price needs some rest due to profit-taking. Therefore, the price action changes from impulsive to corrective.
How to determine the trend change from impulsive to corrective?
The first indication of the corrective trend is that the price moves towards the dynamic moving average after an impulsive movement. Later on, the price will violate the moving average, but it will not create any new high or low.
The above is the perfect example of the corrective trend. Here we can see an uptrend where the price corrected lower towards the moving average. The speed of the bearish correction is weaker than the bullish impulsive momentum.
So, the critical identification of a corrective trend should be-
- The corrective trend appears after an impulse.
- Most of the corrective trends are counter-trend.
- The corrective trend usually moves towards the moving average.
- Trend traders typically wait for the corrective trend to end and join the impulsive trend.
Identify Volatile Trend
After the impulse and correction, we should be aware of the market volatility. In the volatile market structure, the price remains in the range instead of moving within an uptrend or downtrend.
When a currency pair’s fundamental condition is unstable, investors struggle to join the price rally, but both bulls and bears try to control the price.
Let’s have a look at some critical characteristics of the volatile trend-
- The price violates near-term highs and lows in the volatile market structure but does not show any specific direction.
- Both buyers and sellers try to take the price in their path.
- The price volatility from a significant level might indicate a possible trend reversal.
- The price violates the dynamic support and resistance nature of moving averages.
Now let’s see the practical example of how you can predict the volatile trend using the 20 Moving Average-
Here, we can see that the price moves higher with an impulsive pressure and becomes volatile in the marked area. Later on, in the volatile marked area, the price moves below the 20 EMA but suddenly moves up. Later on, it moves lower again instead of continuing the bullish trend, showing market volatility.
Lastly, sellers took control over the price and managed to take the price down. Therefore, the price volatility after a bullish trend indicated the trend change. As a result, the price moved down with an impulsive pressure towards the downside.
Mean Reversion Technique to Predict the Forex Market Trend
Here we will see the mean reversion technique that is suitable for identifying intraday price trends for any currency pair.
In the financial market chart, the price level and moving average try to remain closed due to a gravitational force. Suppose that the price moves up or down, then the gap between the price and the dynamic moving average will expand. Later on, the moving average and the price will come closer with a corrective trend.
Therefore, if the price moves aggressively from a moving average, there is a higher possibility that the price will move towards the dynamic due to the gravitational force.
In the above image, we can see the price moves higher aggressively from the dynamic 20 EMA, and the gap between the price and MA reached the maximum level. As a result, the price moves down with the magnetic attraction towards the 20 EMA before making another bullish leg.
However, while taking an entry from the mean reversion, you should follow some guidelines-
Move one or two time frames lower to see the price action at an extended area and take trades if it matches your strategy. Make sure that there is a strong support/resistance or event level at the extended area.
While taking the entry, read the price carefully and enter the trader after watching an appropriate candlestick pattern.
Drawbacks of Moving Average
Like other trading indicators, the moving average is lagging, and it provides a signal after the movement happens. It is often difficult to trade with a single moving average in the chart.
However, you can minimize the risk by using multiple moving averages values— one of the best ways to trade using the moving average is using 200 SMA and 20 EMA together. If the price comes below the 200 SMA and 20 EMA, you can consider the bearish trend as strong. Conversely, when the price moves above the 200 SMA and 20 EMA, you can think it a strong bullish trend.
However, even if you follow multiple moving averages, you cannot remain completely risk-free. The forex market is associated with some risks that are almost impossible to avoid. Therefore, the best way is to follow strong money management rules in every trade.