How to Establish a Directional Bias

One of the hardest questions a trader has to answer is: Should I be buying or selling? Establishing a directional bias is simply a matter of understanding higher level charts, support and resistance, price action and the overall tendency that the market will continue to move in one direction or another, until something equal or greater may cause a break and shift the tide on the higher level charts. The directional bias plays a huge role in the counter trend versus trend following strategy. Ultimately directional bias will help you choose the direction of the trend and whether you’re going to go long and buy, or go short and sell.

Once you have established a directional bias, psychologically speaking, you can have more confidence executing our trading strategy because you already know specifically what we’re looking for. Having a directional bias means we’re no longer reactionary traders, but we plan the trades in advance and we become less emotionally attached to the markets and ultimately more proficient traders.

Developing a Directional Bias

Strategically speaking a high probability setup is one that has been thoroughly prepared in advance and the process of developing a bias is part of that preparation. Establishing a directional bias is a two part process:

  1. Forecasting where the price is more likely to go up (or down).
  2. Trigger Conditions or the trading rules that confirm your market bias.

It’s not enough to establish a directional bias, and you’ll also need to have some trading rules to confirm your market bias otherwise we might end up being more wrong than right. This is a good habit to have and it will definitely improve your rate of success. Trading is much more about the way we think as it’s about our entry technique or trading plan. In fact, we can say trading is probably more about the thinking process than it is all of the other things. We think, we analyze and we arrive at a judgment or a conclusion. After we arrive at that directional bias, we try to execute our judgment and do that at a good price so we can make a profit.

Directional Bias through Price Action

The easiest way to establish a directional bias is through price action. If prices are moving higher, making higher high and higher lows, traders should form a directional bias to buy. If prices are moving lower, making lower lows and lower highs, traders should form a directional bias to only sell.  Last but not least, you need some trigger conditions to confirm your bias and you can either use your own strategy or you can simply use a Forex Momentum Strategy.

 

Figure 1: USD/JPY Daily Chart

Figure 1: USD/JPY Daily Chart

Directional Bias through Moving Averages

The directional bias can be determined through the use of technical indicators such as the Moving Averages. In technical analysis, the 200-day moving average is considered to be one of the most powerful moving averages. Simply put, if the price is trading above the 200-day moving average, traders should form a directional bias to buy and if the price is trading below the 200-day moving average, traders should form a directional bias to sell.

Figure 2: AUD/USD Daily Chart

Figure 2: AUD/USD Daily Chart

Conclusion

The process of developing a directional bias needs to be kept as simple as possible otherwise, it can lead to analysis paralysis and more confusion in your trading activity. The directional bias can also act as an additional filter to your existing trading strategy. Ultimately, having a directional bias will force you to only trade in the direction of the predominant trend. Since the market has the tendency from time to time to move in a very choppy environment with no clear directional bias you have to develop the discipline of having no position when a clear directional bias can’t be formed.