3 Simple Ways To Identify Trending Markets – Part 1
One of the first pieces of advice given to novice traders is trade with the trend. The problem is most newcomers to forex can't even tell where the trend is, so it is pointless to ask them to trade it. In this new series of articles we'll look at 3 different ways to identify trending markets and avoid those pesky ranging periods.
Method Number 1 – Support and Resistance
One of the simplest ways to identify trending markets and avoid ranges is drawing support and resistance levels. On the chart below we can see a long sideways market on the EUR/USD 1 hour chart.
The ranging market lasts from August 6 to August 21 2012, almost 12 full trading days and it contains just over 270 1 hour bars. The Euro traded between 1.2240 and 1.2442 for close to 2 weeks before breaking out on August 21. See the chart below.
2 Ways To Trade Support And Resistance
There are 2 ways to trade this breakout. Method number one can be seen in the picture above and its very straightforward. You just enter right away as soon as there is a break above the resistance or reverse for short, on a break below support.
The second way to trade S&R levels is to wait for a retest of the level. You wait until the price breaks breaks out of the range and then comes back to retest it. See the chart below for this example.
Price breaks out in the afternoon on August 21, but almost 24 hours later on the 22nd price is back retesting the resistance at 1.2442. In the example on the chart above, the EUR/USD only broke the level by 12 pips, it reached a low of 1.2430 during the retest, then it shoot back up. After the quick and shallow retest the Euro resumes the uptrend and eventually rallies a few hundred pips from this point onward.
Advantages and Disadvantages of the 2 Methods for Trading Support and Resistance
There are obvious advantages and disadvantages for the 2 methods of trading support and resistance. The advantage of the first method of trading S&R is that it gets you in the trade when it happens, there is no possibility of being left without a position when the market finally breaks out. This is also the biggest disadvantage of the second way of trading S&R, there will be times when price just breaks out without a retest, leaving you waiting at the station while price keeps chugging along.
The biggest disadvantage of the first way of trading support and resistance is the many false breaks that happen at strong and defined support or resistance levels. After a situation like we had in EUR/USD, a very long ranging period of close to 12 trading days, everybody will be watching the top and bottom levels at 1.2240 and at 1.2442. There will be many orders placed to buy above and sell below this range. The effect of this may be that price will rally and just pierce the upper resistance level for a short time, trigger a bunch of buy orders and then turn back below into the range, stopping out the buyers in the process.
In the next article we'll look at the 2 other ways to identify trending markets, in the meantime experiment with support and resistance trading and see which method of trading them you prefer.