Trading 101: Trend Indicators
Arguably the simplest but most powerful type of Technical Analysis…
When a trader is looking for trends, the first thing he will look at is the price. Which is shown bouncing between 2 artificial lines. Together these lines are forming a channel, which could be trending upwards or downwards. Once a trend is spotted, the trader will trade according to his strategy and keep pushing for profit until the trend ends. At this point traders will put their strategy on halt, re-evaluate it and adjust it to a new trend.
A small drop in prices may lead any trader to freak out and sell his or her position. By looking at the trend, you could be able to see that the drop might have been a slight hiccup in an ever-increasing price rise. Therefore looking at trends could be good an indication to view larger potential shifts in prices.
Most of the indicators that are common with trend trading are associated with moving averages.
Moving averages are used to identify new trends and trend reversals through calculations of price averages within a certain amount of periods. They are used to filter out the price noise from the fluctuations. The most common ones use 5, 10, 20 or 50 periods to spot trends that are close to the current price of the asset, and 50, 100 or 200 periods for longer-term trends.
Moving averages are divided into two types: Simple Moving Averages (SMA) and Exponential Moving Averages (EMA). An SMA is a normal moving average that consists of a certain number of periods. An EMA gives greater weight to recent periods to shape the moving average, it follows the price more closely than the SMA.
SMA’s and EMA’s can be used for different purposes. Commonly, they are used to identify trend reversals, this happens when a short moving average crosses a long one, as shown in Figure 1, where a ’20 periods moving average’ crosses a ’40 periods moving average’. The idea here is simple, the short term trend is crossing a long-term trend, thereby signifying a trend reversal.
However, some trading strategies are using only a single ‘moving average’ indicator to spot the lower or upper line of a trend channel. When it’s a downward trend, it will be used as a resistance and when its an upward trend, it will be used as a support. Depending on the number of periods of a moving average, the indicator can be used to spot long, medium and short-term supports and resistances. The more periods it takes into account, the longer the trend it will spot.
The Moving Average Convergence/Divergence (MACD) indicator is one of the most popular moving averages. The MACD shows the relationship between a 26-candles EMA and a 12-candles EMA. From there, the MACD line is calculated by subtracting the first one from the second one. Finally, there is a so-called signal line, which is a 9-candles EMA of the MACD line.
This technical indicator is usually used to foresee trend reversals and trades along upward and downward trends. There are two ways in which the MACD can be used:
- Through bullish and bearish crossovers between the MACD and the signal line
- A bullish signal will take place when the MACD line rises above the signal line. What this suggests is that the movement of the price will be upwards. A bearish signal occurs when the MACD line goes below the signal line, insinuating exactly the opposite.
- MACD line and price divergences.
This helps to pinpoint the end of a bullish/bearish rally. It will be considered a buy signal when the price and the MACD line diverges during a downward trend. When the price keeps on trending down and the MACD line starts going up, as shown in Figure 2, it suggests that the current downward trend might be over. After this it will potentially lead to a trend reversal, offering a trading opportunity.
Designed by Perry Kaufman, Kaufman’s Adaptive Moving Average (KAMA) is a moving average based on a fast 2 period EMA, and a slower EMA of 30 periods. It adds an efficiency ratio which will account for the strength of the trend and the volatility of the indicator. Like every moving average, the KAMA is used to visualize the trend and as well will indicate how strong and volatile it is.
This indicator is usually defined as an intelligent moving average, since it takes more aspects into account than a regular moving average. The KAMA is used in a similar way as a normal EMA, with the addition that it indicates if a trend is stronger or weaker. If the moving average has pinpointed a trend and the efficiency ratio suggests that it is strong (with enough change upward or downward within a period of time), it will be indicating that the trend is solid enough to be traded.
Cryptohopper offers the possibility to base your trading strategy on relevant trend indicators. Apart from the ones explained above, you can find DEMA, MESA, T3, TEMA, WMA, and TMA on the platform. Once you understand the basics of these indicators, try to invest some time in backtesting and tweaking. Eventually, you will be able to make a trend strategy of your own!
All in all, trend indicators are widely used for trading strategies, it doesn’t matter if you trade forex, stocks or crypto. When you become capable of locating trends, you’ll be able to apply this knowledge to every market. So have fun trying out trend indicators and as always, happy hopping!
Originally published at www.cryptohopper.com.