The first step a chartist will do is to identify the market condition. Markets can either be trending or not trending, which is often referred to as a trading or ranging market. The basic definition of a price trend was originally mentioned in the Dow Theory. A trending market is a market which is moving in a clear direction, either up or down. This movement usually does not happen in a straight move, but rather a zig-zag movement in price. Being able to determine whether a market is trending or trading is very important in executing strategies and the use of technical indicators. Too often people use trend indicators to determine trades in a trading market, and vice versa.
A trending market provides excellent trading opportunities. A market is roughly trending 50% of the time, the rest of the time it is not, so be on the lookout for when opportunities arise. A lot of the trading strategies found online are designed for trending markets. A famous market saying is “trade with the trend”, or “the trend is your friend”. Especially for beginning traders, picking a strategy that is ‘with’ trend can help increasing your rate of success.
Generally speaking there are two types of trending markets, up and down. An up-trending market is when the prices makes higher highs and higher lows. Vice versa for a down-trending market condition, which is defined by lower lows and lower highs.
Tools helping you identify a trend are Moving Averages and the ADX, definitely check them out. It is MUST KNOW knowledge to be successful.
Ranging or Trading Market
A ranging market condition is defined by price “trending” sideways with a band. The price is moving back and forth between a higher price resistance and lower price support level. These trading ranges can be small or large, if the range is very small the market would be considered to be in a chop (sideways movement with very limited up- or downward movement).
Sometimes a third form of market behavior is suggested called a broadening market. A broadening market condition is defined by higher highs and lower lows.
Runs and Pullbacks
When we review the trending markets more closely we can see that a market is not constantly moving up or down. But overall it’s moving towards one direction, the trend. In the overall trend we see periods of a decent move against the overall trend. These moves are called pullbacks. These pullbacks often retrace to a previous support or resistance level. Pullbacks can often be an opportunity to get into a trade for a good risk/reward ratio. After a pullback the trend usually continues, often called “runs”. To be a little bit more specific on the support and resistance part, when we are in an uptrend, a pullback is a descending move to the last broken resistance level. Conversely, in a downtrend a pullback is a descending move to the last broken support level.
So after determining what the market condition is, the second step any trader should do is to analyze and identify in what phase the currency is trading in.
The best way to make a killer in the market is to learn how to identify when price is either running or pulling back. Most of the high probability trade set ups can be found after a pullback of a strong trending market. For the more experienced trader buying on the pullbacks and selling after the run will lead to extraordinary returns.
Besides pullbacks towards former horizontal support and resistance levels, they also occur in conjunction with measuring instruments like Fibonacci levels and technical indicators such as moving averages. In later blog posts we will get into the exact method of using these tools but for now it’s useful to know that how far a trend will likely pullback can be determined using key Fibonacci levels and moving averages.
Finding the right moments to open a position during a pullback is not just simple placing a trade when you see a pullback developing. You need to apply several procedures and tools to make an estimated prediction of where the market is likely to reverse.
So far we extended our trading vocabulary with terminology as: trending market, ranging market, up-trend, down-trend, broadening market, pullback, a run. It is time to add a little more. Next section will be about Swing Highs, Swing Lows, Major Highs and Major Lows. With these tools from a chartists toolbox in hand we made a big step in analyzing the markets and move into support and resistance. But first things first:
A swing high or swing low refers to a peak/trough in price. The term “swing” is added to distinguish between other peaks and troughs, like daily highs and lows.
Besides swing highs and lows, there is also something as Major Highs and Lows. A previous major high and low is a common and reliable support or resistance level. These major highs and lows are really easy to spot on the chart. A major previous high is a price level that stands out prominently on a chart.