A basic skill required to be a successful trader on the forex market is the ability to recognise the trading environment. The trading environment represents the current activities of traders on the market. Acquiring this skill can help you take advantage of the environment by creating a strategy that works in the current environment.
The forex trading environment is defined as the current condition of the forex market. Being aware of the current condition of the market helps you to make better trading decisions. The forex market is traded under two conditions.
A trend in the forex market is an indication that the price Is moving in one direction. Sometimes, the price may move against the trend (as in, move in the opposite direction), but only for a short period of time. The longer timeframe, however, shows the price moving in one direction. Trends are usually upward (bullish) or downward (bearish).
An easy way to determine the direction of a trend is to draw a trend line. Trendlines connect the lows or highs to determine price direction. The lines connect two or more lows or highs in a long unbroken line. Straight lines projected outward show an upward or downward trend, while a choppy line shows that the market is ranging (Daily FX).
An uptrend occurs when the trend line indicates an upward direction (price is rising). Uptrends can be recognised by higher highs and higher lows.
Downtrends are recognised by lower highs and lower lows. Here, the trend line points downward, indicating that the price is falling.
Trends usually occur in markets with a lot of liquidity. The more liquid a currency pair, the more movement the pair will have which will, in turn, result in the price moving strongly in one direction. Major currencies, as well as pairs that include the dollar, tend to be more liquid than others (Baby Pips).
In a range-bound market, price moves sideways rather than upward or downward. When the price is ranging, it bounces between a high price and a low one. The high price acts as a resistance level, which the price seems unable to cross. The low price, on the other hand, acts as a support level – which the price also can’t seem to cross (Baby Pips).
For the ranging market, the best pairs to trade are crosses. These are major currencies that do not include the dollar such as; AUD/NZD, EUR/JPY, EUR, CHF, and many others.
Currency pairs range majorly due to supply and demand. After either supply or demand wins the battle to take over the market, support or resistance levels break and the price goes on to test a new support and resistance level.
For the different trading environments, different trading strategies should be applied in the various trading environments, to be able to acquire profits.
Indicators to Be Used in Different Market Environments
Average Directional Index (ADX)
ADX is a great way to determine the strength of a trend before opening a position. This indicator uses values from 0 -100 to determine if the price is moving strongly towards one direction or if it’s ranging. After determining the direction of the trend, ADX can be used to determine the strength of the trend. The higher the values on this indicator, the stronger the trend.
Average directional index is also a great way to determine if the market is range–bound. When ADX is below 25, the market is said to be ranging (Forex Tips).
Bollinger bands are a great indicator for breakout strategies, they expand when volatility is high and contract when it’s low. When the bands expand, there is an increase in volatility and the price is likely to move in one direction. When the bands contract, the price is said to be moving within a certain range (Baby Pips). As long as the bands are expanded, the price is volatile, and traders can take advantage of this.
Relative Strength Index (RSI)
Relative strength index is another technical indicator which can be used to measure the speed and change of price movements. A currency pair is considered overbought when it’s above 70 and oversold when RSI indicates that it’s below 30. Since it’s a directional indicator (it confirms the trend direction), this can help you determine the best time to enter a trade (Fidelity).
Each indicator has its own unique strengths, and, depending on the trading environment, these strengths can be used to maximise profit for each trader.