From the September 01, 2012 issue of Futures Magazine • Subscribe!

Trading forex with the trend

Conversely, retail traders typically cannot cause a trending market. They can participate in a trend and benefit greatly from a trending market, but do not have the capital to move the market in a trending direction for a prolonged period of time. 

Because most retail traders do not see the actual large money flows that cause a trend to start and continue, they rely on technical tools as a proxy for measuring trend strength. This is where Fibonacci retracements come into play. 

Retracement zones

Strong trends do not move in a straight line, but take steps higher (or lower). A trend move consists of a fast and directional move higher (assuming an uptrend), followed by a smaller correction to the downside. The corrections typically are caused by traders who are anxious to take profit and counter-trend traders who are trying to pick a high extreme. The combination swings the market to the downside for a period of time. If the market is in a strong uptrend, typically there are measurable characteristics for the corrections within that broader trend. 

Most traders know that there are a variety of Fibonacci retracement levels that can be applied to trend moves as a way to measure corrections. These levels also can be used to measure the strength of the trend.

The first key retracement is the 23.6% level, followed by the 38.2%, 50%, 61.8%, 78.6% and 100%. Although charting purists say all are important, in trending markets experience shows that the 38.2% and the 50% levels are the most relevant. The area between these two Fibonacci levels can be termed the “Correction Zone.”

If the Correction Zone can hold after a trend move higher, it says two things about the uptrend: Buyers likely are well-capitalized traders who are supporting the market at the discounted retracement price, and the counter-trend sellers are not taking back control.

Conversely, if the market trends higher, then corrects below the Correction Zone, it says: Capitalized buyers who forced the market higher were not committed to the trend totally, and sellers (who also may be well capitalized) took back some control.

When this happens, faith in the trend’s strength diminishes. Also it may be time to exit the position and reevaluate the market. 

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