The Foreign Exchange market trades 24 hours a day, six days a week, and reflects the relative value of one country's currency relative to another's. The exchange rate is the price that one currency can be exchanged for another. Similar to other capital markets, a currency-pair exchange rate can trade in a specific trend that can be predicted using a number of different methodologies.
Defining a Trend
A trend in the foreign exchange market occurs when the exchange rate moves in a definable path over a specific time. One of the most efficient tools used to capture a trend is a moving average. The moving average of an exchange rate is the average of a certain number of exchange rate values that changes over time. For example, a 20-day moving average is calculated by averaging the past 20 days; on the 21st day, the first day is dropped from the moving average calculation.
Using Moving Averages as Trend Predictors
One of the most widely used predictors of a trend in the FOREX market is a moving average crossover. This technique aims to identify the middle of a trend by evaluating periods when a short-term moving average climbs above or falls below a longer term moving average. When a short-term moving average of exchange rates climbs above a longer-term moving average, the crossover is predicting higher trending prices.
Momentum is often used as a predictor of potential trends in the FOREX market. Using moving averages, an investor can calculate momentum, which can in turn predict a trend. One of the most popular momentum indicators is the Moving Average Convergence Divergence -- MACD -- indicator created by Gerald Appel. This indicator measures the difference between a short-term moving average and a long-term moving average, comparing that calculation to the moving average of the difference. Appel defined certain default periods that can be used to calculate uptrends and downtrends in the FOREX markets.
Support and Resistance
Another predictor of a FOREX trend is the movement of exchange rates through prior levels of support of resistance. Support is defined as price levels where demand buoys prices, while resistance is defined as price levels that are capped by supply. When exchange rates move above resistance, an uptrend could be forming, while price movements through support could foreshadow future price declines.
David Becker is a finance writer and consultant in Great Neck, N.Y. With more than 20 years of experience in trading, he runs a consulting business that focuses on energy hedging and capital market analysis. Becker holds a B.A. in economics.