Forex Trends and Corrections

Forex Trends and Corrections

4.1. What is a Forex Trend?

A forex trend is broadly defined as the direction in which a currency pair is moving. Currencies usually do not rise straight up, nor do they fall vertically down. It is more common for them to retrace some of their decline or advance, before continuing in the direction of the original forex trend. Each forex trend, therefore, consist of a series of price thrusts in its direction and price reactions contrary to it ( which are also called retracements, corrections or pullbacks). Trends are differentiated by their direction and by their duration.

Currency trends are divided into three types according to their direction - uptrend, downtrend and sideways trend. In an uptrend each currency price thrust reaches a higher level than the one before it and each currency price reaction stops at the level higher than the preceding reaction. In a downtrend every price thrust reaches a lower level than the thrust before it and every price reaction stops at the level lower than the previous reaction. In a sideways market both price thrusts and price reactions don't substantially exceed their previous counterparts.

forex trend types

forex trends thrusts reactions

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Forex trends are also divided into three groups according to their duration - major, intermediate and minor trend. Major forex trends last from one to three years. Intermediate forex trends continue form three weeks to three months. Minor forex trends are completed in less than three weeks. Major forex trends are best viewed on the daily charts, intermediate trends - on the hourly charts and the minor trends - on the 15-minute charts. Major trends are formed by the intermediate price thrusts and reactions, each of which are intermediate trends. Intermediate trends are in turn made up of minor price thrusts and reactions, each of which are minor trends. Elliott wave principle is based on this relationship between trends of different degree. Under this principle, price thrusts are called impulse waves and price reactions are called corrective waves. The following picture shows the relationship between trends and Elliott waves of different degrees. Each trend unfolds within its own trend channel formed by two parallel trendlines of the corresponding degree.

Relationship between Trends and Elliott Waves of Different Degree

forex trends elliott waves different degree

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different degree trends

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different degree trends

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Meta4: Major down and up forex trends are sometimes compared to the rising tides in the ocean, intermediate forex trends - to the waves and minor forex trends - to the ripples on the water's surface. When the tide is rising each advancing wave reaches and each receding wave stops further into the shore than its predecessors. Similarly, in a major up or down trend each major price thrust and each major price reaction exceeds the level reached by the previous price thrusts and reactions. When an unexpected news hits the market (strong tap on the water surface), the counter-trend move is likely to stop at the trendline which defines the prevailing trend - in the same manner that the random ripples are absorbed by the larger waves flowing in the direction of the tide. When the trend is strong its waves tend to feed on all types of water taps (good or bad news) - which is not the case with the weakening trend. A long-term forex trading strategy used by some of the hedge funds is to enter the market in accordance with a major up or down trend (i.e. when the tide is rising), at the end of the major price reactions (i.e. when receding waves reverse), and exit the market when the major price thrusts are completed (i.e. when advancing waves reverse). Minor trends (i.e. ripples) are then used for timing purposes. This approach is the basis for the Elliott wave currency trading strategy described on this site.

Most major trends on the currency markets are also closely correlated with the dynamics of the interest rate differential between the currencies which form the currency pairs. For example, a combination of the period of rising interest rates in United States and stable interest rates in European Union is likely to be accompanied by a sustained major downward movement in the EUR/USD pair. The downtrend is intensified by investors who sell Euros borrowed at a lower rate in Europe for the US dollars - so that these can then be relent at higher long-term interest rates in the US (the trading strategy also known as the "carry trade"). The reverse will happen and a major uptrend in the EUR/USD is likely to be produced when the US interest rates remain constant while the European Union interest rates rise (or are kept at a higher level than in US for a long period of time).

As a general rule, the greater the expected interest rate differential between the two currencies in a currency pair the more likely is the development of a strong major trend in it. In other words, probability of a major trend's development in a currency pair depends on the relative macro economic situation (as measured by the fundamental analysis) of the countries whose currencies form the pair. Most major up and down forex trends are terminated when the interest rate differential starts to shrink.

4.2. Measuring and Trading Currency Trends

The main objective of the technical analysis is to capture the maximum percentage of a trend's movement (be it minor, intermediate or a major trend) - by entering at the start and exiting at the end of its price thrusts. To do this you have to be able to accurately measure and follow the trends from the moment that they start to develop. Two of the most popular technical analysis tools used for following the trends are the trendlines and the moving averages. You can use these tools to open positions in accordance with the prevailing trend right at the moment when the next price thrust is likely to begin (at high-reward/low-risk entry points). Please review the pages dedicated to each of these and the following tools for more information on how to apply them in your trading.

The best entries in accordance with a trend occur after the currency price reactions have run their course. Three tools commonly used for confirming the end of corrections are the fibonacci retracements, indicator signals and continuation price patterns. To get the maximum profit from trend trading it is important to establish when one of the trend's price thrusts or the whole trend has ended - and then take partial or full profits on your positions, respectively. Some of the tools used for this purpose are reversal price patterns, indicator divergencies, fibonacci and price channel projections. The following examples demonstrate these entry and exit techniques:

capturing price thrusts

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capturing price thrusts

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Note: Elliott wave principle is entirely devoted to capturing price thrusts in forex trends of all degrees. Currency traders are highly advised to get themselves familiarized with this analysis method.

Note: Most mechanical forex trading systems are trend-following in nature, which means that they are designed to identify currency trends and to trade in their direction.

4.3. Mastering Trend Trading

Effective trend trading on the currency markets requires that you regularly review your charts for the signals regarding the trends of all three degrees - major, intermediate and minor. This task is best performed if you have a fixed number of technical analysis tools plotted on the 15-minute charts for the minor trends, on the hourly charts - for the intermediate trends and on the daily charts - for the major trends. The instruments that you plot on these charts will be the tools which you have specified in your forex trading system (which should also contain the guidelines on what types of forex trends you are planning to trade and what are the satisfactory conditions for trade entries and exits).

Most of the forex trading books will provide you with detailed guidelines on how to set up your charts to follow the three degrees of trend and how to combine the signals from each trend type to maximize your profits. One of the best books teaching how to combine signals from different degree trends is "Trading for a Living: Psychology, Trading Tactics, Money Management" by Alexander Elder in which he describes his Triple Screen Trading System. Under this system forex trends of three different degrees are systematically analysed for trading opportunities which occur when the signals from all of them align with each other.