Market Direction - Trend StrengthThe strength of a trend can be a key factor in predicting future price movements. This post will specifically cover how to identify trends, how to determine trend strength, and how to use it to your advantage when trading the markets.
Characteristics of a Trending Market
To begin, let us understand how to identify a trending market.
A trending market is a market that is either making higher highs followed by higher lows (UPTREND) or lower lows followed by lower highs (DOWNTREND).
What does this typically look like? Let's see:
Uptrend
Downtrend
Now that we understand how to identify uptrends and downtrends, let's delve further and discuss how to use trend strength to your advantage when trading the markets.
Fibonacci Retracement Tool
The Fibonacci retracement tool is used in trending markets to determine how strong the trend is. It uses natural numbers to determine the high-probability price levels that the market will hit and continue in its initial direction. This method will use four Fibonacci levels: 38.2%, 50%, 61.8%, and 78.6%.
One thing to mention is that in a trending market, the chart is made up of two waves: impulsive and retracement. After an impulsive wave, a retracement wave will usually form; after a retracement wave, the impulsive wave will usually form.
The impulsive wave represents the strong momentum of buyers and sellers. The retracement wave shows the weakness of buyers and sellers.
Therefore, we must look at the retracement wave when it comes to deciding the strength of a trend. For example, in an uptrend, the impulsive wave will be bullish; therefore, the retracement wave will be bearish. In a downtrend, the impulsive wave will be bearish; therefore, the retracement wave will be bullish.
The retracement wave shows the strength of the opposite side of the market. For example, if the impulsive wave is bullish, buyers are stronger. Then, in the retracement wave, sellers will try to dominate the buyers.
Therefore, the deeper the retracement goes, the stronger sellers will be than buyers, and the weaker the bullish trend strength will be.
With the Fibonacci retracement tool, there are three scenarios to determine trend strength:
Strong Trend Strength: 38.2% Fibonacci Retracement
Moderate Trend Strength: 50%–61.8% Fibonacci Retracement
Weak Trend Strength: 78.6% Fibonacci Retracement
The above examples show why the Fibonacci retracement tool can be extremely effective in determining not only how strong a trend is, but also how likely it is to continue past the beginning of the impulsive wave.
Bollinger Bands
Bollinger Bands are very effective in reading trend strength. Bollinger Bands are based on price volatility, which means that they expand when the market is trending and there are big prices, and they contract during sideways consolidations when the market ranges.
Bollinger Bands consist of two outer bands (top and bottom bands) on each side and a moving average in the centre between the outer bands (middle band).
One of the main reasons Bollinger Bands are so effective in reading trend strength is that they do not lag as much as other indicators because they always change automatically with the price.
Three important points to note when using Bollinger Bands to read trend strength:
If price pulls away from the outer band and heads towards the middle band as the trend continues, this is a key indication that the trend strength may be weakening.
During strong trends, prices stay close to the outer band and significantly away from the middle band.
Repeated pushes into the outer bands that do not actually reach the band indicate a lack of trend strength.
Let's see a chart example of Bollinger Bands reading trend strength:
As you can see, using Bollinger Bands can provide traders with very useful information about trend strength and the balance between bulls and bears.
Price Rejection
We do not always need indicators or tools to read trend strength; it is possible to do this just by looking at a naked chart. The way rejected continuations or reversals happen on charts can be a huge indicator of being able to read trend strength. Before understanding the price rejection, it is important to know about the wick or shadow of the candlestick.
Upper wick
The upper shadow shows that the price went up and then came down again. This indicates that buyers wanted to increase the price, but sellers dominated the buyers to push the price back down.
Lower wick
The lower shadow represents that the price went down and then came back up. This indicates that sellers wanted to lower the price, but buyers dominated the sellers to push the price back up.
Identifying price rejection
Traders should first wait for the price to reach a strong support or resistance level. Then, at the support or resistance level, candlesticks will likely make wicks opposite the trend due to the strength of the level. For example, wicks or shadows will form on the upper side at the resistance zone, while at the support zone, wicks or shadows will form on the lower side of the candlesticks.
These wicks or shadows are identified as price rejections in the market.
Price rejections are very important, especially in identifying trend strength, because they accept or reject the identification of key levels in the market. For example, if you are unsure whether a support zone will hold or break, you can see whether price rejection will occur at that level.
Let's see a chart example of price rejection and how you can use it to identify trend strength:
The chart above is proof alone that trend strength can be identified by just looking at the price action of a chart.
Understanding the strength of a trend does not have to be complex. Trend strength can be identified simply by using the three different techniques we have covered in this educational post.
The best thing we can all do as traders is to be simplistic and not overcomplicate things; this becomes especially easier when you accept that nothing in the market is certain.
Each market has its own unique market conditions and will not trade rationally all of the time. Therefore, when a trade does not go your way even though your trend strength signals were high and you followed the market, understand that it is just one trade and that the market is completely neutral. It is neither personally on your side nor personally against you.
Trade safely and responsibly.
BluetonaFX
