Trends in the currency market can last for a very long time because currencies as an asset class represent the health of a country and its economy. The outlook for a currency pair will not change on a dime, which means that trends will last for weeks, months and, in many cases, even years. The reason this happens is simple.

Barring any unforeseen disaster, countries where unemployment is high and companies are suffering will not go from performing terribly to performing strongly in a matter of days or even weeks. Usually, the economy of a country gets progressively better or progressively worse over the course of a few months, and this progression is reflected in the price action of the currency.

Also, because they are responsible for thinking ahead, central banks never go from raising interest rates one month to cutting them the next. As a result, usually, when they start increasing or decreasing interest rates, the first move is not the last.

A recent example is the U.S. dollar, which fell against the Euro throughout 2006 and 2007, or in other words, for 2 years straight. Or, look at the New Zealand dollar, which sold off against the U.S. dollar for 4 years straight between 1997 and 2000, before rallying for 3 years with virtually no retracement.

It is important to learn how to catch a trend in the currency market because, as you can see by the previous examples, more money can be made joining the trend than fading it. There is a reason most of the hedge funds focusing on currencies tend to make money in trending markets and lose money in range-bound markets.

How can you catch a trend in the currency market?

A simple method I like to use employs moving averages. Traditionally, moving averages are used as measures of support and resistance. In order to gauge when a new trend has emerged, I look for the price of a currency to break specific moving averages.

More specifically, I like to use the 50- and 100-day simple moving averages because they are long-term enough to be statistically significant but also short-term enough to help provide an early signal for a shift in trend.

If I am looking to go long or to participate in a new uptrend, what I want to see is the price rally above both the 50 and 100 SMA. When this happens, the implication is that the current move is strong enough to break the average for the past 50 and 100 days. As long as the price remains above both of these moving averages, the uptrend is intact. On the flipside, if the currency’s price moves below both the 50 and 100 SMA, the trend has turned bearish and will remain so until it moves back above the 50 SMA.

In the accompanying chart of the EUR / USD, I have labeled the three instances where a new uptrend has emerged and the two instances where an uptrend has ended. I call this "spaghetti price action" because the moving averages wrap around the price, reflecting range conditions.

When the EUR / USD enters into a new uptrend for the first time on our charts in November, the EUR / USD is trading around 1.2730. Remember: We need to see a close above the moving average, not just a pierce. We stay long until a close below the closest moving average, which is almost always the 50-day SMA. In this case, we exit at 1.3000.

The second time the EUR / USD enters into an uptrend, we go long at 1.3130 and exit the trade at 1.3445.

The third time, we enter at 1.3545 and exit at 1.3530.

If we had only made these 3 trades in EUR / USD between November 2006 and August 2007, we would have netted 575 pips:

1. Buy at 1.2730; close at 1.300 (1.3370) = +270
2. Buy at 1.3130; close at 1.3445 (1.3680) = +315
3. Buy at 1.3545; close at 1.3530 = -10

Total profit = 575 pips

As you can see, this is an extremely simple way to determine a trend, and more efficient methods can be used to achieve a better entry or exit price.

If you take a quick look at the chart, you will see that we left a lot of money on the table on all 3 trades because the EUR / USD retraced significantly before the position was closed. If we had exited each position at the high of the moves, the profit would have been 1,495 pips:

1. Buy at 1.2730; high on move was 1.3370 = +640
2. Buy at 1.3130; high on move was 1.3680 = +550
3. Buy at 1.3545; high on move was 1.3850 = +305

Total profit = 1,495 pips

Of course, selling at the high tick is impossible, but, if you used your own exit methods, which might be more efficient, it is realistic to capture half of that profit, or 747 pips, which is still close to 200 pips more than if you had exited exclusively on moving averages.

*Reprinted (and modified) with permission from Kathy Lien of DailyFX.com