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Price Movement Trends and The Theory of Retracements in Forex

Author: Christophe Williams
Christophe Williams
All publications of the author

 

As a forex trader, you will likely notice that there are different price movements or shifts that define the market. You can make profits if you bet on the right price movement. The good thing is that there are different ways to determine where the price will shift so that you can make the right decision.

 

For currencies, there are some price movement trends that you can follow to predict the market correctly. The price movement of a currency is the movement in one direction or another. The trend can be upward or downward, but it cannot reverse its course. 

 

When a currency moves in an upward direction while on a downward course, it is called an up-trend. On the other hand, when a currency is moving down but it was on an upward course, it’s called a down-trend. You can also use the theory of retracements to figure out how a particular asset class will move.

 

What are Price Movement Trends?

 

Price movement trends are the general direction of price over a period of time. They are created by the collective actions of market participants and can be broken down into three main categories: uptrend, downtrend and sideways trends. A good understanding of these price movement trend can help you find the next shift in a currency price. 

 

An upward price movement trend occurs when the prices of a certain currency have been on the rise for a significant period. Uptrends generate momentum in prices up to a certain point before they break down. The degree to which prices move higher depends on how far they have gone up before starting their decline into lower levels, known as ‘triangle’ patterns. As the market starts, several traders will take long positions to take advantage of the uptrend. 

 

With a downward price trend, the price of the currency will fall slowly over time. Downtrends generate a falling trend until an uptrend is witnessed, which is usually when there is no more room for further declines. The degree to which prices move lower depends on how far they have fallen from previous highs, known as ‘head-and-shoulders’ patterns. You can make money from a downtrend by selling or shorting an asset class in the forex market.

 

Sideways trends occur when there has been no movement for some time but are still supported by strong volume activity from buyers. In this case, the price of a currency pair may remain stagnant meaning it will neither reach its highest prices nor will it reach the lowest prices. This means that although you might not see any dramatic changes happening overnight, it could be just around the corner. A lot of traders tend to ignore sideways trends with the belief that they cannot make money from such a market. However, scalp traders often make money from such markets since they only need small price movements to make money. 

 

 

The Different Types of Trend Trading Strategies




 

It is one thing to know the different types of trend trading strategies but it is another thing to use these trends to make profits. Here are some of the trend trading strategies that you can use to make profits. 

 

Using The MACD Trading Indicator

 

The MACD (Moving Average Convergence Divergence) is a technical indicator that is used to identify changes in the strength and direction of a trend in price. It is calculated by subtracting a 26-day exponential moving average from a 12-day exponential moving average. When the resulting MACD line crosses above a signal line, it suggests that the price may rise. 

 

On the other hand, if the MACD line crosses below the signal line, it could indicate that the price may fall. A histogram is often plotted alongside the MACD line and signal line to show the difference between the two. The MACD is widely used because it is simple to use and can be applied to various financial instruments, but it is important to consider it alongside other analysis tools for a more complete understanding of the market.

 

The MACD is a popular indicator because it is simple to use and can be applied to a wide range of financial instruments. However, it should be used in conjunction with other technical and fundamental analysis tools, as no single indicator can provide a complete picture of the market.

 

 

Using The RSI Trading Indicator

 

 

The RSI, or Relative Strength Index, is a technical indicator used to gauge the strength of a trend in price. It is calculated by dividing the average of upward price changes over a certain period by the average of downward price changes over the same span, then multiplying this ratio by 100 to yield a value between 0 and 100.

 

 A value above 70 is typically seen as indicating an overbought market, while a value below 30 is often taken as signaling an oversold market. The RSI is often plotted on a chart with horizontal reference lines at 30 and 70, and it can be used to predict trend reversals, confirm trend strength, and identify overbought or oversold conditions. 

 

However, it is important to remember that the RSI should be used in conjunction with other analysis tools, as it cannot provide a complete understanding of the market on its own. Additionally, the RSI is a momentum indicator and may not be as effective in ranging or choppy markets.

 

 

The ADX Trading Indicator

 

This is a technical indicator used to assess the strength of a trend in financial markets. It is calculated using three exponential moving averages: a positive directional indicator (+DI), a negative directional indicator (-DI), and a smoothed average of these two indicators (ADX). The +DI and -DI are based on the difference between the high and low prices of a security during up and down periods, respectively.

 

The ADX is plotted as a line on a chart, with values ranging from 0 to 100. A reading above 25 is generally considered to indicate a trending market, while a reading below 20 is considered to indicate a ranging market. A reading above 50 is considered to indicate a strong trend, while a reading below 50 is considered to indicate a weak trend. 

 

Traders often use the ADX in combination with other technical indicators to confirm trends and make trading decisions. As with the other indicators, it should not be used in isolation and is only one tool among many that can be used to analyze financial markets.

 

 

The Theory of Retracement

The theory of trend retracement is simple. A trend is simply a series of higher highs and higher lows. It can also be either up or down, but it’s important to note that the way you determine whether it’s an upward or downward trend will depend on how long your trade has been open.

 

Retracements are a technical analysis tool that shows the shape of price movement. This is a chart pattern that appears when prices fall below or rise above previous highs and lows. A retracement can be reversed within a day or two, so it’s important to examine your trade plan before entering an order.

 

The most popular method of calculating a retracement is the Fibonacci Retracement tool, which uses numbers derived from the golden ratio. The tool itself has been around since the late 1980s and is used by technical traders all over the world. The most common form of retracement is the symmetrical triangle. This pattern appears when the price is stuck between two converging trendlines, making it difficult for buyers and sellers to agree on a price. When this happens, neither side can gain an advantage over the other

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It's important to know how to trade retracements because they are one of the most common types of reversal in forex. A retracement is when price drops below its previous high point and then bounces back up again, forming a relatively small but powerful recovery that lasts for several days or weeks before resuming its descent into new lows. This can happen either as part of an important trend change, or as part of an intermediate market cycle.

 

For example, if you bought at $100 and sold at $120 (an increase), then your trend was up for the entire period between those two price levels. If instead you had been holding for only one month before selling out of your position at $100, then your trend would have been down during that time period because prices were falling after each new high (or low).

 

There are many ways to identify retracements. Some traders look for a price that has been hit three times, while others look for other patterns like triangles and wedges. Regardless of how you identify it, the point is that when price reaches its lowest point after a decline, it usually bounces back up slightly before continuing its downward trend. 

 

In the same way that support levels predict upwards momentum when they're broken, so too do retracements predict downwards momentum when they're broken. The reason that we use these types of trend lines is because they allow us to see whether the trend is still intact. If we can see that there are higher highs and higher lows, then it’s likely that prices will continue following this same path. The more often prices reach new highs or lows, depending on whether your trade was up or down. 

 

Fibonacci theory

 

The Fibonacci numbers are the ratios of consecutive Fibonacci numbers. For example, if you draw a line from A to B and then from B to C, then you can see that there is a ratio between these two points: 1:1 (or 1:2). This means that halfway along this line (C) there will be another ratio of 1:2 or 2/3rds as well as 3/4ths further on (B). In other words, halving your distance by going halfway along an existing path makes it twice as far again.

 

This phenomenon also applies when we look at price movements across time or markets. For example, if we take our original starting point in USD/JPY being 100 dollars per yen and go up from there every month until July 2023 where we end up at 120 dollars per yen. But only after having gone down from 120 before, then logically speaking both paths should lead back into each other somewhere around midpoint value. 

 

Fibs for plotting retracements

 

Fibonacci retracements are calculated by taking the high, low and close of the previous swing and dividing them by a number between 0.382 and 1.618. The resulting ratio is then used to plot the retracement levels on the chart. The longer you hold a position, the more important it is that your trend be up. 

 

If you bought at $100 and sold at $120, for example, then your trend was up for the entire period between those two price levels. This is because the Fibonacci sequence is a ratio of numbers where each number is the sum of the previous two. If we take our example above, we have 100:120:144:161:181 and so on. This means that if we were to add up all these numbers then divide them by two to get rid of all decimals, then we would get back to our original starting point at 100 dollars per Euro. 

 

Trendlines are another popular tool for technical traders. They can be used to determine where a stock should be headed based on the price action of previous swings. Trendlines are created by connecting two points on a chart in order to create an imaginary line that shows where prices are likely to head next. The following chart shows how you can use trendlines to identify areas of support and resistance. 

 

Overlapping Fibonacci retracements within the same trend

 

It is very common to see overlapping Fibonacci retracements within the same trend. In fact, it's often necessary for traders to look at these lines when they want to predict price movement. The main reason why these lines are so important is because they can help you determine when the trend will change or if it has already changed.

 

When you see overlapping Fibo's, it may mean that there is a good chance of an upside reversal coming soon and possibly even a new uptrend forming, which would be considered as an up-trend. However, this does not mean that your trade should automatically go long since there could also be some resistance/support on both sides which could cause problems during your trade setup process if not taken into account beforehand by using other tools such as chart indicators like RSI & MACD etcetera.

 

How to trade retracements

 

Trading retracements can be a useful strategy for traders who are looking to take advantage of temporary reversals in the price of a financial instrument. By identifying key levels of support and resistance, traders can potentially enter trades at more favorable prices and potentially profit from the subsequent move in the direction of the original trend.

 

One key factor to consider when trading retracements is the strength of the underlying trend. A strong trend is more likely to resume after a temporary retracement, while a weak trend may be more prone to reversals. Therefore, it can be helpful to use other forms of technical analysis, such as trendlines or moving averages, to help identify the strength of the trend.

 

Another factor to consider is the volume of trading activity. A high volume of trading activity can indicate strong buying or selling pressure, which may make it more likely that the price will continue in the direction of the trend. On the other hand, low volume may indicate a lack of conviction among traders, which could make it more difficult to predict the direction of the price.

 

Finally, it's important to keep an eye on economic and political events that could impact the value of a currency or other financial instrument. Fundamental analysis can help traders understand the underlying factors that may drive price movements, and can help inform trade decisions.

 

Overall, trading retracements requires a combination of technical and fundamental analysis, as well as a well-defined trading plan and risk management strategy. By keeping these factors in mind, traders can potentially increase their chances of success in the Forex market.

 

Final thoughts: Price movement trends and the theory of retracements

 

It's worth noting that trading retracements is a strategy that can be applied to any financial market, not just the Forex market. However, the specific tools and techniques that traders use may vary depending on the market they are trading in. For example, in the stock market, traders may use chart patterns, such as head and shoulders or cup and handle patterns, to identify potential areas of support or resistance. In the commodities market, traders may use trendlines or moving averages to identify potential retracement levels. Regardless of the market being traded or the specific tools being used, it's important for traders to have a clear plan in place and to manage risk effectively. This may involve setting stop-loss orders, limiting the amount of capital being invested in any single trade, and diversifying investments across different markets or asset classes.

 

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Risk Warning: Your capital is at risk. Statistically, only 11-25% of traders gain profit when trading Forex and CFDs. The remaining 74-89% of customers lose their investment. Invest in capital that is willing to expose such risks.