Forex – Major Market Types

by Tom Black
Forex – Major Market Types

Wondering how the movements of the forex market can affect your trading? Markets move in either of three directions; up, down, and sideways. When the market is going up or going down, it is termed a trending market, whereas if they are moving sideways, it is called a ranging market. 

Why Do Markets Change?

The principle of demand and supply drives the forex market. When people want to buy more the prices will increase, and when people want to sell more, the prices will fall.  But what drives a trader to sell or buy in forex trading?  Unlike what happens in the stock market, forex trading is significantly influenced by underlying economic conditions and fundamentals.  It is wise on your part as a trader to pay keen attention to the changing global economic conditions since it can adversely impact your trading daily.

When referring to a currency, we are actually talking of the complete economy of the specific country. In the case of the EU, there is more than one country associated.  So there is always a mighty lot to look at whilst trading on forex.  It is prudent and essential to study both the data fundamentals and also the way in which currency prices are affected by the way supply and demand are relative to one another.  Whilst equity trading is driven by speculation, this is not true for currency trading.  Forex trading is not driven by speculation only, but rather is driven by the fundamental demand for the currencies in a currency pair relative to one another.  For example, it’s not that traders just want to hold USD more than, AUD, but more conversion of AUD to USD will take place for macro reasons, and economic factors.

Trending, Ranging, and Their Variations

To trade with the flow is to trade with the trend.  Looking for short entries when clearly, the trend suggests that buying might result in a smooth trade is uncalled.  There are traders who are not actually trading trends. Speculators will combine their regular trading approach with the concept of trading with momentum and its direction.

The graph below shows how the markets keep alternating between different phases.

The graph shows how the markets keep alternating between different phases

Trends are identifiable by trend lines or price action that highlight when the price is making higher swing highs and higher swing lows for an uptrend, or lower swing lows and lower swing highs for a downtrend. All markets are witness to uptrends and downtrends. An overall increase in price can be termed as uptrend.  But what goes up will have to come down and cannot stay up for long – markets are very oscillatory in action this way.  The market will lose steam and there will be a price reversal. If this reversal in pattern holds, it will be termed as downtrend.

There are times when the market is not moving in an up or down trend but is seen to be having a side trajectory.  This is called a ranging market.  As compared to trending markets, trading in a ranging market can be seemingly tough.  Without a clear trend to hop on to, it can be challenging to identify the entry and exit points in a ranging market.  Nevertheless, there are ways in which the possibility of making a profit in ranging markets also exists.

Markets Weather Variety & Adapting to Change

As you saw above, the markets are always in a trending or ranging phase. This simply means that if you are working with a trend trading strategy, then there is a possibility of you losing money in range markets.  And if you operate with a range trading strategy, you will possibly lose money in a trending market.
Let us learn about the phases and how to invest during each phase.

Phase 1 – Accumulation Phase

This is the phase after fall in prices.  It is the consolidation phase and it’s characteristics are as follows:
  – Takes place usually after a 6-month fall in prices
  – Can last from 6 months to even a year
  – Since bulls and bears are in equilibrium, price is contained within a range
  – Up days and down days have pretty much equal ratio
  – Price hovers back and forth around the 200-day moving average
  – Lack of interest results in sort of low volatility
A good strategy is to trade the range itself when you are trading in the accumulation phase.  Trading must be avoided in the middle of a range as prices may swing back easily to the highs and lows.

Phase 2 – Advancing Phase

There is a price breakout from the accumulation phase, and it enters the advancing phase.  This is also called uptrend and consists of higher highs and lows.
  – Last between a few months to years
– Price trades higher over time with more up days than down days
  – Short term averages move higher than long term averages and price is above the 200-day moving average
  – Volatility during the later stage of the phase is higher due to higher interest

 At this phase, you will want to capture the market trends, and therefore, using a trend trading strategy is useful here.  Trade the pullback and trade the breakout here.
You must avoid counter-trend in such a phase as the prices are going higher – going with the flow will return you bigger gains.

Phase 3- Distribution Phase

This happens after there is a rise in prices and again, the market enters into a consolidation phase.
  – After around 6-month rise in prices, a long period of consolidation takes place during the uptrend
  – The ratio of up days and down days are pretty much in balance
  – The 200-day average starts to flatten out after price decline   
Trading the range itself is a good approach in this phase and try to go long rather than short.  Again, trading must be avoided in the middle of the range.

Phase 4 – Declining Phase

After the distribution phase and after the price breaks down, it goes into decline.  This is also called a downtrend.
  –  A series of higher highs and lower lows are formed after price breaks out of distribution phase
  – There are typically more down days than high
  – Price is below the 200-day moving average
  – Volatility is also high due to panic and fear
Again it is time to deploy the trend trading strategy – when in a downtrend, avoid going long.

Conclusion

It is essential to keep monitoring and reading the market very closely in order to identify the different phases it is getting into.  By using the right approach towards each phase, you avoid losses and earn more profits.

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