(Please click on the accompanying chart to enlarge. Chart courtesy of FX Solutions’ FX AccuCharts.)

I often get asked about different ways one may determine trending conditions, or lack thereof, in the forex market. There are many ways to do it, including trendlines, trend channels, linear regression, slopes of moving averages, the Average Directional Index indicator, simple visual estimation, and more.

One rather reliable method that I tend to use often is called the “correct order of moving averages.” For this technique, I usually use five different exponential moving averages (EMAs), although more or less may be used according to a particular forex trader’s experimentation. The periods of the moving averages may also be varied according to experimentation, but I will generally use the following five EMA periods: 10, 20, 30, 50, and 100. Many traders have been known to choose periods based upon Fibonacci numbers (for example: 5, 13, 34, 55, and 89). Extensive experimentation with the quantity and periods of moving averages helps tremendously in identifying a good set of multiple moving averages that works well for the market being traded.

Once the quantity and periods are identified, trend determination with multiple moving averages simply consists of seeing whether the EMAs are in the correct order at any given time. If the longest period EMA is on the bottom and progressively shorter period EMAs stacked above it, with the shortest period EMA on top, that can be considered the correct order for an uptrend. If the shortest period EMA is on the bottom and progressively longer period EMAs stacked above it, with the longest period EMA on top, that can be considered the correct order for a downtrend. Whether an uptrend or a downtrend is indicated, strategies can then be implemented to enter into trades in the direction of the trend. If the moving averages are NOT in correct order, that is an indication that there is NO directional trend. In this event, one might be well-advised to stay out of trading in that particular currency pair at that particular time, especially if one prefers to trade in the direction of the prevailing trend.

- James Chen, CTA, CMT

* I will be key speaker at FXstreet.com’s International Traders Conference in Barcelona, Spain in October 2009 - for more information, please go to: www.traders-conference.com .

* For information on my book, Essentials of Foreign Exchange Trading (Wiley), please click here.

* Follow my intraday forex updates on Twitter: http://twitter.com/JamesChenFX

Price action on GBP/USD has broken down below the neckline of a rough head & shoulders pattern. This occurs after price previously broke down below a key uptrend support line extending from the March low. The right shoulder of the current head & shoulders pattern reached up to just above the 1.6600 level before dropping below the 1.6265 horizontal neckline just yesterday. For more technical analysis on this currency pair, please click here for Thursday’s (8/27/2009) Chart of the Day.

Price action on AUD/USD has just descended back down to an uptrend support line extending from an early March low. This occurs after price bounced up off the line several times just last week. Like other dollar-based currency pairs, AUD/USD is currently entrenched within a rather prolonged consolidation. An emergence from this consolidation could take two forms. For more technical analysis on this currency pair, please click here for Wednesday’s (8/26/2009) Chart of the Day.

Price action on EUR/USD has continued to traverse up a parallel uptrend channel that has been in place since early June. Late last week, price was able to break out above a short-term, bearish counter-trend line, and was targeting the top of the channel once again. For more technical analysis on this currency pair, please click here for Tuesday’s (8/25/2009) Chart of the Day.

After approaching strong resistance right below 0.8500 a few times since the beginning of the month, price action on AUD/USD is once again approaching that resistance level. This occurs after price dipped down to an uptrend support line extending from early March lows. For more technical analysis on this currency pair, please click here for Monday’s (8/24/2009) Chart of the Day.

Price-oscillator divergences in the forex market are instances when there is a technical imbalance between the price movement on a currency pair and an oscillator’s movement. Divergences should not be considered complete, self-contained trading strategies. Rather, they should be regarded as signals that warn of some potential impending directional bias. As such, divergences are not standalone indicators - they should confirm or be confirmed by other technical indications.

The oscillator that is used to identify divergences can be any of a number of different chart studies that can be found on any forex charting platform. These include: Stochastics, Relative Strength Index (RSI), Moving Average Convergence/Divergence (MACD), MACD Histogram, Rate of Change (ROC), Momentum, Commodity Channel Index (CCI), Williams %R, or any other oscillator that travels between defined horizontal bounds.

Once an oscillator is chosen, the process of searching for divergences is straightforward. There are two types of divergence that every technical forex trader should be aware of: regular divergence and hidden divergence.

Regular divergence is the most popular type, and it is what most traders mean when they refer to the general concept of divergence. Regular divergence serves as an early potential signal that a loss of momentum and a potential price reversal may be in the making.

The signal is manifested in an uptrend when price makes a higher high while the oscillator makes a lower high. This is called bearish regular divergence, and warns of a potential reversal and possible subsequent move to the downside. The opposite is called bullish regular divergence and occurs during downtrends. In a bullish divergence, price makes a lower low while the oscillator makes a higher low. In both cases, bearish and bullish, the oscillator diverges from price, giving an indication that price momentum in the currently prevailing direction may be waning.

If either type of regular divergence is identified on a currency chart, forex traders should immediately seek confirmation of a potential reversal before taking any trading action. This confirmation can take many forms, and usually involves other technical indications like a trendline or moving average break, a reversal candle pattern, or some other chart reversal pattern.

In contrast to regular divergence, the second type of divergence, called hidden divergence, can be considered the polar opposite. This signal is also a technical imbalance between price movement and oscillator movement. But instead of signaling a potential reversal, hidden divergence is used primarily to signal a potential continuation in the prevailing trend. As with regular divergence, there are also two basic manifestations of hidden divergence.

Bearish hidden divergence usually occurs during a downtrend, and is characterized by price making a lower high while the oscillator makes a higher high. In this case, price and the oscillator are diverging in their signals, but the overriding signal that should be taken from an occurrence of bearish hidden divergence is a potential continuation of the lower highs in price, which is the equivalent of a potential continuation in the prevailing downtrend. Bullish hidden divergence usually occurs during an uptrend, and is characterized by price making a higher low while the oscillator makes a lower low. In this case, price and the oscillator are diverging in their signals, but the overriding signal that should be taken from an occurrence of bullish hidden divergence is a potential continuation of the higher lows in price, which is the equivalent of a potential continuation in the prevailing uptrend.

As with regular divergence, confirmation should also be sought for instances of hidden divergence before any trades are actually placed. This confirmation can also take many forms, and usually involves other technical indications.

Divergences are common and useful signals that are best utilized as warnings, or confirmations, of potential reversals (regular divergence) or potential trend continuations (hidden divergence).

- James Chen, CTA, CMT

* I will be key speaker at FXstreet.com’s International Traders Conference in Barcelona, Spain in October 2009 - for more information, please go to: www.traders-conference.com .

* For information on my book, Essentials of Foreign Exchange Trading (Wiley), please click here.

* Follow my intraday forex updates on Twitter: http://twitter.com/JamesChenFX

Price action on USD/CAD has formed another short-term uptrend correction within the context of a strong longer-term downtrend. This bullish correction has occurred after price hit a 10-month low at 1.0630 in the beginning of this month. Currently very close to the short-term uptrend support line, price could either continue the bullish correction with a bounce up off the trendline, or it could seek to continue the overall downtrend by breaking down below the trendline. For more technical analysis on this currency pair, please click here for Thursday’s (8/20/2009) Chart of the Day.

Price action on EUR/USD, a 4-hour chart of which is shown, is currently in consolidation near the bottom of a parallel uptrend channel that has been in place since early June. This parallel uptrend channel exists within the context of a much larger parallel uptrend channel that has been in place almost since the beginning of the year. In the current smaller channel, two dynamic support/resistance areas are of key significance. For more technical analysis on this currency pair, please click here for Wednesday’s (8/19/2009) Chart of the Day.

Price action on GBP/USD, a 4-hour chart of which is shown, has descended to approach the bottom of a parallel uptrend channel that has been in place since early June. Currently, this lower channel border resides around the 1.6300 price region. If the current bearishness in this currency pair continues down to break below this uptrend support line, the 1.6000 price region should serve as a significant further support target to the downside. In the event of a bounce at or near the uptrend line, the 1.6600 region should continue to serve as intermediate upside resistance.

Within the context of a prolonged horizontal trading range on USD/CHF, price has formed a small triangle consolidation. Any substantial break of this triangle should present a potential opportunity within the current trading range. For more technical analysis on this currency pair, please click here for Tuesday’s (8/18/2009) Chart of the Day.