Trend indicators help to define the prevailing price direction by smoothing out data over a certain period of time. Trend indicators show the direction of trade (buy or sell) and may also identify good entry/exit points. Successful use of trend indicators enables a trader to consistently make profitable returns from their trade. This article highlights the best trend indicators that a trader can use to better understand the market price direction.
- Moving Averages
The moving average is a plotted line that measures the average price of a given market price over a specific period of time. These time periods are defined as 5-day, 20-day, 100-day or 200-day depending on the duration of interest. It is considered the most common technical indicator even by fundamental analysts. The three basic types of moving averages are:
- Simple Moving Average– this method takes the sum of the past ‘n’ prices and divides them by their number.
- Exponential moving average– Takes the average of the past ‘n’ prices but puts more emphasis on the most recent prices.
- Weighted moving average– This is the average of the past ‘n’ prices with a linear weighting.
When the price is in alignment with the moving average the market is said to be trending. If the two are opposing each other the market is slowing down and you should expect a reversal/retracing. A horizontally moving average signals the presence of a sideways market in which there is little or no gap between the price and the moving average.
The steepness of the moving average line indicates the market strength and at times, price exhaustion. A moving average also acts as support by being the floor that keeps the price from dropping lower or resistance if it acts as the ceiling for upward moves.
- MACD (Moving Average Convergence Divergence)
This is an oscillating indicator that measures both trend and momentum. It fluctuates around zero and is often one of the first oscillators to be applied on a trader’s chart. MACD measures the spatial relationship between two exponential moving averages. The most common exponential moving averages inputs are of 12 and 26 periods with the signal line of 9 periods.
In a down-trending market, the fast moving average moves down faster than the slow moving average. When the fast moving average diverges from the slow moving average, MACD is able to highlight that relationship. Traders get to notice the change in trend from an early stage. Using longer-period moving averages helps to slow down the MACD indicator; this simplifies grading of the trend or momentum.
When MACD crosses over to a positive region it usually signifies a buying opportunity. If it crosses over to a negative territory it signifies a selling or short trade opportunity. However, MACD is often supplemented with other technical indicators to create a more vivid picture of the market trend.
- Relative Strength Indicator
Relative Strength Indicator (RSI) is also a popular technical analysis indicator used by traders to speculate on when a price may be overbought or oversold. RSI is used in trending or range-bound markets to locate more suitable entry/exit prices. RSI being an oscillator means that it is plotted between the values of 0-100. When a trader discovers an uptrend they should identify the RSI reversing before joining back in the trend direction. When the indicator is above 70 the price is viewed as overbought and due for a correction. If the indicator is below 30 the price is viewed as oversold and due for a bounce. A strong uptrend will have the price reaching 70 and beyond for a sustained period while a strong downtrend has the price at 30 or below. A trader should consider buying near oversold conditions in an uptrend and place a short trade near overbought conditions in a downward trend. In such circumstances, RSI helps the trader make the right decision.
The indicators discussed above are the best for every trend trader who wishes to extract profits from trends. It is important to note that there is no single trend indicator that is an outright key to the market riches. Risk management and trading instincts are two factors that should be considered on top of these indicators when creating a strategy. Take your time in studying charts and avoid uninformed rushed decisions. This will keep your chances of trading successfully up.