“The Trend is your Friend” is a catchy saying. It describes a situation in which a currency pair moves in a predictable trend for an extended period. A bull trend in the forex market is one where the base currency moves higher relative to the counter currency. The question for forex traders is how do you determine if a forex pair is in a bull trend, and what makes a bull market in the currency arena? Several factors go into the future movements of a currency pair.
These factors include trade flows, interest rate differentials, and self-fulfilling technical analysis. If you trade forex in a bull market, you either want to look at buying on dips or breakouts, take advantage of oversold conditions, and look for minor pullbacks to take advantage of counter-trend reversals.
What Drives a Forex Bull Market?
Several factors can drive a forex bull market. The answer to the question of what is forex trading is transactions where investors, traders, or commercials exchange currencies. The forex market is the capital market’s most liquid, with more than $6 trillion in notional transactions traded daily. Some of the drivers of the forex markets include trade flows. Consumers who want to purchase goods or services in a country generally need to buy their currency to purchase those items. For example, if a U.S. liquor distributor wants to purchase French Bordeaux wines from a winemaker in France, they would likely need to exchange their dollars for Euros to buy the wine.
Another factor that drives forex markets is interest rates. When traders look at the forex market, they tend to avoid purchasing currencies where they need to pay away interest rates to hold their currency over time. When you buy a currency, you generally do it in the spot market, which requires that you deliver your money to your counterpart within two business days. You must transact in the forward market if you want to hold your currency position for longer than two business days. Holding for more than two business days will require a forward rate, addition, or subtraction from the spot rate based on forward points.
An example of the benefits of trading on a trend driven by interest rate differentials is the EUR/USD. The dollar has been in a bull trend, perpetuating as U.S. short-term interest rates have increased relative to Euro rates. Traders would instead earn the difference between U.S. short-term interest rates by holding the dollar versus the Euro than paying away interest rates if you keep the Euro versus the dollar.
How Can You Recognize a Trend in the Bull Market?
One way you can determine if there is a bull market in forex is to use technical analysis. Technical analysis is the study of past price movements to help determine the future direction of a currency pair.
If you look at the chart of the dollar index, you can see that the dollar has been under a prolonged bull trend for more than one year. The bull trend can be identified by looking for a moving average crossover, a technical analysis indicator. When the 50-day moving average crosses above the 200-day moving average, a long-term uptrend is considered in place.
This moving average crossover occurred in August 2021 and signaled that the dollar index could be in a bull trend. If you decide to use moving averages to help you determine if a trend is in place, remember that a moving average is a lagging indicator and will tell you what has happened. You can use a shorter-term moving average or longer-term moving averages to capture the formation of a trend. You might consider that the bull trend in the dollar index is complete when the 50-day moving average crosses below the 200-day moving average.
When a bull market occurs in the currency world, the exchange rate movements are not a straight line. There will be points during the trend where the currency pair pulls back. You can see in the dollar index chart that the basket of currencies pulled back to the 50-day moving average several times.
One way to see if an exchange rate is likely to pull back while trading in a bull trend is to see if the currency pair is overbought or oversold. You can do this by using the stochastic. A stochastic is an oscillator that moves within a defined range. The chart’s fast stochastic is an index bound by 100 and zero. Levels above 80 reflect periods when the dollar index is overbought. Levels below 20 signal periods when the dollar index is oversold. During a bull trend in the dollar index, you can consider taking short-term profits when the stochastic indicates overbought levels. You might add or take a new position when the dollar index is oversold. When you use a stochastic, you need to understand that a market can stay overbought over oversold for an extended period.
The Bottom Line
When you are forex trading in a bull market, you first want to know that you are in a bull market and familiarize yourself with the factors that likely drive the upward momentum in the bull market. Some drivers include the interest rate differentials that drive the forward market, causing many investors to focus on the higher-yielding currency.
Technical analysis is one of the most efficient tools to determine if a currency pair is in a bull market. For example, when the 50-day moving average crosses above the 200-day moving average, the exchange rate is likely in a bull trend. A trend is when the market moves in one direction for an extended period. Remember, a bull trend is not a straight line. There are times when the market pulls back and is overbought or oversold. In these situations, you might be able to use a stochastic to help you determine if you should take profit or add to your position.
Overall, these scenarios are hypothetical and only reflect market possibilities, thus they are not to be taken as trading advice.