A market can only be two things. It can either be a trending market or a ranging market. Maybe we can make that three since trending markets can trend up or down. In short, a trending market moves in a single direction while a ranging market has a price that bounces between specific price highs and lows.
Trending markets and trading
As we have mentioned, trending markets are the ones that move in only one direction. However, we do not mean that it will be a perfectly smooth line when we say this. The price might still oppose the trend’s direction on shorter time frames up close, but a chart with a longer time frame will say otherwise. It will show that the price moving against the trend’s direction in a short time frame is only a retracement. During uptrends, the note would be higher highs or higher lows and lower highs or lower lows on a downtrend.
Traders would usually trade major currencies or currency pairs involving US Dollars in a trending market. They are more liquid compared to the others. It is essential to take note of liquidity when your strategy involves trends. More liquidity means more volatility and movement. More currency movements mean more possibilities for the price to move in a single direction, unlike the ranging market where the price bounces in small ranges.
The best way to determine whether a market is trending or not, you can monitor the price action or use technical indicators or tools. Let us cite some of them:
- ADX (Average Directional Index). This indicator created by J. Welles Wilder uses a 0-100 range to know whether the price moves in one direction, trending, or ranging. If the value is more than 25, it means that the price is strong or trending. The higher the number, the stronger the trend. This indicator cannot tell whether the trend is going up or down. All it tells us is a positive figure that tells us if there is a trend since it is a non-directional indicator.
- Moving averages. A simple moving average is an alternative for ADX.
- Bollinger bands. Although traders often use Bollinger bands in ranging markets, it is also effective in detecting trends. Believe it or not, price ranges from 70 to 80 percent of the time. Price ranges are expected, while trends are pretty rare. Bollinger bands have the standard deviation formula. To determine a trend, place bands with a standard deviation of 1 and another set with a standard deviation of 2. There are three price zones sets: the sell and buys zone and the no man’s land.
The sell zone, buy zone, and the no man’s land.
Before we close the topic, let us clarify these so we can further clarify Bollinger bands. The sell zone is somewhere between the standard deviation 1’s (1SD) two bottom and standard deviation 2’s (2SD) bands. The price should be close to the bands for us to consider it as a sell zone. On the other hand, a buy zone is somewhere between 1SD and 2SD’s two top bands. The price should also be close to the bands for us to consider it a buy zone.
The market has a hard time finding direction is usually somewhere between the standard deviation bands. If the price is not there and in no man’s land, then the price will close in that area. In a nutshell, prices in sell zones confirm downtrends, prices in the buy zone can confirm uptrends.