Trends, Ranges and Trendlines

The safest trades are in the direction of the trend. Why? Because "the trend is your friend"... well, it can be - and this is usually true until it ends.

Honestly, traders are most likely to get spanked by the market when they trade against the trend (I have) especially if they enter a trade late. This is because moves going against the overall trend, in a trending market, generally don't last long - and can turn on a dime. The good news is, when you trade with the trend, late entries won't necessarily hand you your head on a platter.

Ranges

But who cares about trading against the trend (i.e., trading a correction)? After all, currencies trend really well. And, if you can spot the beginning of one, there's an excellent chance you'll be able to take your chosen pair for a nice, long, profitable ride.

How long will the ride last?

Good question. This is where knowing a pair's daily average trading range (ADR) comes in handy. As of September 2006, the 60-day ADR for the pairs I typically track were approximately as follows:

EURUSD - 83

GBPUSD - 140

USDCHF - 86

USDJPY - 131

Note: Remember, this is an average. There are times when pairs are range-bound, moving in a channel (sometimes a tight channel).

Based on the above ADR's, it should be fairly obvious that, if you can identify market turning points, there's plenty of profit built into almost every trading day - which is why figuring out pivot points (i.e., where the market will begin trending) in advance of the trading session can be worth its weight in pips. So, to help us stay in a trend once it reveals itself - and work it for every possible pip - we use (among other things)...

Trendlines

As far as indicators go, trendlines are critical. Here's why: currencies typically break their trend at or very near a S/R point or other key price level (like pivot points), then head in the opposite direction. So it pays to learn how to use them.

You probably know that price rarely goes straight up or down. Instead, when trending, it wanders from the start of its trading range to its finish... in a zigzag, sort of like the way my mother-in-law drives (I'm kidding). That is, it takes two steps forward and one step back throughout the day. This is called "retracing" and the net result is a "retracement."

In an up trend, retracements form a series of higher-lows that lead to higher-highs; in a downtrend, the opposite occurs: lower-highs and lower-lows. Please see the above chart to get a visual on this. (You'll learn more about retracements in the Fibonacci section.)

Now, understand there are trends within trends; meaning, smaller moves occur within larger moves. Depending on one's skill, with almost every close above or below a trendline, there's an opportunity to trade in the new direction. Again, look at the above chart and try picking-out the smaller trends.

"Hey, just one minute" you say.

Okay, let me guess. You're wondering, "When is a trend too small to trade?"

My answer to you is, "it's a personal thing," and should probably be based on, at least in part, on one's trading proficiency along with proper money management (e.g., reward-to-risk). I prefer to trade with the 60-minute trend. And, for the record, I'm an active trader, I don't hold positions more than a few hours. Still, regardless of the timeframe and style of trading, you need to use trendlines, which brings us to

Drawing trendlines

To draw trendlines, you'll use the trendline drawing tool in your charting package. In an up trend, connect the consecutive lows. When price closes below a trendline, a bearish reversal may be in the making. In a downtrend, connect the consecutive high points and look for the opposite.

Remember, if price is trending down and closes below a support trendline, the trendline becomes resistance. That said, know once price penetrates a trendline, it sometimes tests the opposite side before finally reversing course.

Important: Because price is constantly moving, a trendline needs to be "dynamic" meaning, as new high and low points emerge you need to re-draw your trendline. What if your market isn't trending? what if it's moving sideways or channeling? No problem. Just like a trending market, both can provide trading opportunities.

On that note...

After the US session close, some currencies tend to move in a channel between the upper trendline and the lower trendline; this is a consolidation pattern, which usually breaks out in the London hours - unless, of course, it doesn't ;- ) Generally, the longer a pair consolidates, the bigger the breakout (this is very noticeable with economic reports).

Understanding channels should help you "trade the news." Trendline reversals at the time of releases immediately indicate the institutional traders' reaction. So, don't try to anticipate the effect of a report. Instead, watch what happens, then jump onboard. Why not let someone else make the first move AND take most of the risk?