Trading financial markets is about interpreting what markets are about to do, and every economist, analyst and trader wants to predict the market’s movement and direction correctly. The key to achieving this is determining whether or not the market is trending or stuck in a range bound condition.
So, just how hard is it to determine a trend? Technically speaking it is not that hard.
To illustrate this, if an instrument posted a higher price while at the same time maintaining a higher low, it is considered to be an up-trend. Conversely, a lower low and a lower high are considered to be a downtrend.
Seems pretty simple so far? Well, next, let’s look at whether it is easy to spot a range bound market. If you see that the price is bouncing up and down, this is considered to be a range bound market.
It is unfair, however, to oversimplify the market direction with an explanation of this kind. As a concept, this approach may have merit; the reality of the situation, however, brings a huge issue into the mix. Both the trend and market direction can be very subjective and it is time frame dependent.
An Example – AUD/USD
Let’s take a closer look at AUD/USD, which is a very good example to use if you want to take this issue apart and see why there are differing views on the currency pair in the market now. To do this I’ll present three different timeframes with three different views of the market condition.
For intraday traders, within the 5 minutes time frame, the AUD/USD appears to be erratic, trending one day and reversing the gains overnight. It is not necessarily wrong to say that within the day itself the market trends up on the 29th January 2013 and trends down on the 30th January 2013. Intraday traders are accustomed to seeing and utilising this rapid change in trend.
Moving on to the one-hour time frame, we encounter swing traders. Now, swing traders – with a medium term view of the market – take an entirely different view. Instead of the erratic whipsaw and trend changes day to day, they’re likely to view the current market condition to be in a downtrend (since the pair creates a lower high and a lower low at every swing in the market since January 23rd 2013). Holding a short position for three or four days would have produced a significantly bigger gain per position compared to that experienced by intraday traders.
Moving on to the daily time frame, we join the group that in previous articles I have identified as longer-term traders, who typically take their views from the daily chart. Longer-term traders viewing the pair from the daily chart would consider the AUD/USD to be in a range roughly between 1.0200 – 1.0600, with 1.0400 as its pivot level since July 2012.
Identifying the range this way provides a trader with a specific entry and exit level and, considering the range bound condition and buying near the bottom of the range or selling close to the top of the range, provides a considerable risk to reward ratio. The downside, of course, is the opportunity missed during the trek across the range.
As you can see, market conditions and trend directions are both very subjective. This makes market views dependent on the time frame within which they are taken – obviously, adding the constraints of particular points in the trading timeline will impact the view and the trading outlook taken from it.
None of the views that I have identified above is wrong. However you can understand the market condition better, and as such reap the benefit of greater understanding, if you consider the view within more than one time frame.
For instance, if you were an intraday trader, you would be able to look up to the one hour time frame to identify the stronger trend direction and decide to only sell, which in turn means you would be minimising the risk of counter trending the market. Subsequently a Swing trader could look up to a daily time frame and isolate key support and resistances from which the pair is likely to bounce off.
There are no set rules to what time frame to look at; however logic would suggest a higher time frame that does not represent too great a difference. Combining the view from a five minute chart and the daily chart is like trying to jump across the Grand Canyon. Having an intermediary like the one hour would provide a much better and more relevant and actionable understanding. One way to consider this is, rather than taking a run and trying to jump the canyon unaided, you are hooked into a glider and ride the currents all the way across. The currents still might shift, but you have a far better chance of making it across in one piece!
Looking Ahead – My View
While on the topic of AUD/USD, the range between 1.0200 – 1.0600 seems likely to remain in play until the middle of the year (2013). The early days of February are critical in determining the direction of the AUD/USD considering the pair is hovering right around the 1.0400 midway of the range. A push below 1.0400 could see the pair continue to fall towards the 1.0200 support of the lower range. A bounce off 1.0400 will likely see the pair testing 1.0600 resistances.
Only a move beyond these barriers will provide a better view of either a return to parity or 1.10.
As always, if you have any questions for me, simply ask me via the Ask the Expert panel here.