Environments You Will Encounter While Trading on the Forex Market
The foreign exchange market is the biggest market in the world right now and it is very liquid. It moves and changes on a daily basis and traders should be well prepared for any challenge they might encounter on their trading journey.
The situation on the market is constantly transforming and in order to make a profit and prevent losing your money, you need to learn to identify these environments and adjust your trading strategy to suit the current situation you find yourself in.
Traders who have more experience than the others already have prepared approaches they plan on using depending on an environment of the foreign exchange market.
Since the foreign exchange market spans over different time zones and allows each trader to choose when and where to trade, they surely do have enough opportunities to see the current state of the market and make a decision whether they want to trade at a certain time or not. A trader has an option to choose more secure environment or a risky one but it is crucial that they possess enough knowledge to be able to recognize these situations and prepare for a possible outcome.
The most common situations on the forex market
When you take a look at the foreign exchange market, the most common environment you will encounter is a trending market. If you are unfamiliar with that term, a trending market is a market that moves in one direction. It is divided into uptrends and downtrends and those have their own sub-categories – higher highs and higher lows when we talk about an uptrend, and lower highs and lower lows in a downtrend.
If your trading strategy involves following the trends, you need to keep an eye on the liquidity of a currency pair you have chosen to trade with. More liquidity means more movement. Therefore, traders who are paying closer attention to the trends usually go for major currencies such as US dollar and pair it up with another liquid currency. More movement means more possibility that the trend will go in one direction for a longer period of time, providing a trader with more opportunities and a larger profit.
Average Directional Index indicator is used for determining trends in the market. It works by using the values from zero to one hundred in order to determine if a price is constantly moving in one direction or not. Any value above twenty-five is a strong sign that a price is currently trending. Higher the number, stronger the trend – it is that simple. But it is also important to note that Average Directional Index is not an ideal way to predict the future of the market. Also, the numbers don’t show you the direction meaning that the numbers can be high, but the value might be in a downtrend nevertheless.
Another possible environment you might find yourself in is a range-bound market. Range-bound market, as the name suggests, is the market in which the price constantly goes up and down between a specific low-price and high-price.
Both of those markers serve as a type of resistance which is unbreakable and the value constantly ranges between those two numbers. This very common movement can be divided into horizontal and sideways when you take a look at the charts. Average Directional Index indicator is also used for identifying a range-bound market. If a value is repeatedly under the number twenty-five and it simply never goes up, that is a clear sign of range-bound market.
Bollinger Bands are typically used for determining if a market is currently range-bound. If a market is less volatile, the bands contract and the bands expand when the volatility is higher. Therefore, you need to take a look at the charts and confirm that the bands are contracted. If they are, the movement of the market is less likely. On the other hand, when the bands start expanding, the market is getting volatile and it will certainly move in one direction. The majority of Bollinger bands will be contracted and they will appear horizontally meaning that the price is making small movements within a range.
Trading in a range-bound market might seem odd to some traders but it is a very popular and common practice. A trader buys a currency at its low price within a bound and the goal is to sell it when it hits the high price, which will bring him a profit. The best currency pairs for this type of trading are the cross currency pairs. Those are the pairs which do not include US dollar. When you take all things into consideration, the most profitable cross currency pair in this situation is EUR/CHF because it is very stable and there are not many oscillations which mean that the price will stay within the range.
Retracements and reversals
A trader should also be aware of two other things and those are retracements and reversals. Retracements are a short-term movements or changes in a trend. They are non-permanent and they usually bounce back to continue the trend regardless of the trend’s direction. Reversals might be self-explanatory for some: they are a change in a trend’s direction. If an uptrend switches to a downtrend, that is a reversal. Of course, it works the other way round as well, meaning that a reversal can be a downtrend which turns into an uptrend. Reversals can happen anytime and because of that, it can be very difficult to decide what to do and which strategy to apply.
Some traders use stop-loss orders in orders to keep their money safe and avoid huge risks if they are trading the trend. It is an excellent plan because it makes sure that whatever happens, you will gain at least a couple of pips and that is still considered a success.
But it is of great importance that a trader is capable of identifying the retracements and reversals and distinguishing one from another. It is easy to be tricked and to mix them up which may lead to unwanted results.
There are a number of indicators which can help you out in figuring out whether you are dealing with a retracement or a reversal. First of them is the fact that retracements usually occur after a large price change while reversals are prone to appearing at all times. Reversals also last longer than retracements and they are considered to be long-term changes to the price. Retracements have a short life span and they will soon return to the starting point. Reversals happen when there is an important change within the world of economy and they are triggered by major news releases while retracements do not react to those influences.
Fibonacci levels are another useful tool which can aid you in recognizing the retracements. It is very similar to Bollinger bounds and once you take a look at the charts, you will realize the resemblance. The Fibonacci levels might go down for a moment but they will return to the trend levels and they will not fluctuate much. If they do and they go beyond the usual levels, you might be looking at a reversal.
Of course, these tools are great for confirming which environment you are trading in but experience on the foreign exchange market does play a huge role here. Once you have a large number of trades under your belt, you will be capable of choosing the right method for identifying these occurrences that suits you the best. It will make your trading easier and more precise.
Being capable of spotting the small changes in the prices is a part of your trading journey. It will show that you understand the market and the way it moves at any time and under different circumstances. Surely, this knowledge cannot come to you right away.
You will need some trading experience and more time you spend on the foreign exchange market will improve your overall trading abilities. If you plan on being a successful trader, and we are sure you do, you simply need to learn to protect your funds and apply different trading strategies to different market environments you might find yourself in.
Having an ability to act quickly and make a right decision in different scenarios are the traits which will lead you to the top. Research and learn as much as you can but don’t expect to be a flawless trader that is not capable of losing any funds right away. You will surely make some mistakes and fail to assess the situation properly but that is just a part of being a trader in the foreign exchange market and every single trader has already been there. The knowledge will come to you over time and you will most definitely see the results in your overall trading performance.
Don’t be intimidated by the charts as they only serve you as a useful guide.Practice makes perfect and with that said, go out there and test your strategies.