The trend is your friend! If this is the first time interacting with the forex and derivatives market, you have already met the industry’s golden goose in that one statement. What is a trend? In the social media age, the most likely answer to this question is the subject of many posts within a brief time. The same is not too farfetched when it comes to the forex and derivatives industry: a trend refers to the overall market direction of an asset’s prices. Unlike the social media trend, the financial markets’ trend may be short, medium, or long term.
If everyone in the forex markets knows that the trend is your friend, why do most traders fail to make money? First and foremost, to take advantage of the movement as a trader, you need to be active in the market type that you are comfortable with:
- Ranging Market; this trend type has the market prices moving sideways with no upward or downward inclination. Market Demand and supply are in equilibrium with neither sellers nor buyers having the upper hand.
- Bullish market; this trend type has the market inclining upwards with higher highs and higher lows. The demand for an asset is greater than the supply resulting in increased prices of that particular asset. Buyers are in control of the market.
- Bearish market; this trend type has the market inclined downwards with lower highs and lower lows. The prevailing market supply is more than the current market demand for an asset pushing prices down.
Trading with the trend or making the trend your friend dates back to before the advent of electronic trading. It is almost guaranteed that every active trader in the markets is seeking out the direction. Therefore, to be part of the minority that makes money in the markets, a trader needs an upper edge to differentiate between actual trends and temporal market reversals. In addition to this, they need to identify the trend early enough hence rides it longer for higher profitability. This is where the Best Trend Indicators come in.
“One man’s medicine is another man’s poison!” Rating the best in anything is relative because it is dependent on individual tastes and preferences. However, when it comes to the best trend indicators, this review settles on the indicators below based on their popularity in being the building blocks of trend-based trading systems, availability on the trading platforms as standard features, and the most successful traders swear by them.
To start us off, we look at the most quotidian of the trend indicators, the moving average.
1. Moving Averages
It is nigh impossible to identify the market trend direction without using the moving average indicator, but it is as rare as a winter swallow. This might be due to its simplicity in execution, coupled with its reliability in identifying the prevailing market trend.
The moving average indicator Achilles heel is its delay reacting to the current market price, lagging effect. In an attempt to overcome this challenge, the moving average has evolved into four major moving average types:
- Simple Moving Average, SMA; assigns the same weight to all the price bars under consideration and is the slowest to react to the prevailing price action.
- Exponential Moving Average, EMA; assigns weights exponentially to the price bars with the current price having more significance in its plotting than its predecessors.
- Smoothed Moving Average, SMMA; is an advancement of the simple moving average that considers more extended period and then uses the price bars’ averages to assign equal weights.
- Linear Weighted Moving Average, LWMA; this uses a weighted coefficient on the price bars then linearly gives the weight.
It matters not the type of moving average used; they identify the trend based on the position od the price bars:
- Active trading of prices above the moving averages shows a bullish trend,
- Active trading of prices below the moving average indicates a bearish dominated market,
- Market prices actively trading within a moving average show a ranging market.
The moving average indicator has also been popularised as a crossover entry strategy: the combination of a fast and slow-moving average with their crossover determining when to activate a trade.
Expert tip of trading with moving averages: lower timeframes should use lower period’s settings with higher timeframes using higher period’s settings. Keep of markets with prices actively trading within the moving average.
Trend lines are not your typical trading indicator but more of a drawing tool. None the less, if used correctly, it is one of the best indicators for identifying the trend and gauging the strength of a trend.
To identify a bullish trend using the trend line, join two successive higher lows and voila, a bullish trend is identified. On the flip side, join two consecutive lower highs to identify a bearish trend. Until the trend line is significantly breached, the market trend is considered intact for as long as prices test the trend line and bounce back.
The incline of the trend line gives insight into the strength of the trend. The more the degree of a slope, the more the market volatility hence, the greater the strength. Caution! A very steep incline on the trend line in most cases is not sustainable for long periods.
The price channel drawing tool is an advancement of the trend line and is another excellent trend indicator. Drawing the price channel follows the same trend line principles: to identify a bullish trend join two successive higher lows and to identify a bearish market join two lower highs.
The interpretation is also similar to when using the trend line. The variation comes in the extra equidistant parallel line. In most cases, prices oscillate between the two equidistant lines, either going up or down.
The price channel indicator is the go-to trading indicator for swing traders because both channels offer trading opportunities as price oscillates between them.
This is also a great trading indicator if interested in taking advantage of a sideways market, ranging market.
Bollinger bands fall under the trading indicator category of price channels. The difference between Bollinger bands and the price channel is that they seek to identify a trend’s onset. How do you determine the beginning of a market movement? For a trend reversal to occur, there must be a shift in power between supply and demand. Bollinger bands give insight into this significant price points, overbought and oversold price zones. Once the market is in this price saturation point, there is usually a high probability of a new market movement.
To effectively carry out the role of trend identification, the Bollinger band is made up of three bands:
- An upper band which identifies overbought price regions hence potential bearish reversal points.
- A lower band which identifies price oversold areas therefore possible bullish reversals.
- A middle band that dictates when to activate either a bullish or bearish position; active trading of prices above the middle band identifies a bullish market while active trading of prices below it hints at a bearish market.
In addition to identifying the prevailing market trend, the Bollinger band gives insight into the determined direction’s momentum. Contracted Bollinger bands are a sign of low momentum while diverged Bollinger bands hint at high trend momentum.
This trading indicator seeks to identify trends at their beginning. It is also known as the “stop and reverse” indicator because it aims to identify when prices change direction. The parabolic SAR Indicator identifies the market trend by forming a series of dots. Formation of dots below the market prices is considered evidence of a bullish market while the formation of dots above the price bars points to a bearish market.
This indicator is also great for identifying trade exits:
- Exit active trade on the formation of a counter parabolic dot.
- Use successive parabolic dots as trailing stops.
Moving Average Convergence Divergence
The moving average convergence divergence, MACD, is a trend-following momentum indicator based on moving averages. It uses a fast and slow exponential moving average and calculates the difference between the two exponential moving averages. The difference between the two moving averages is what is plotted and is known as the MACD line.
A signal line which is another exponential moving average based on the MACD line, usually of period 9, is plotted together with the MACD line. The two lines oscillate around the 0 level, and crossing over this level informs the prevailing market trend; positive MACD lines identify a bullish market while negative MACD lines signal a bearish market. The extreme levels, positive and negative, identify price overbought and oversold areas, respectively.
The discussion above highlights the best trend indicators for use on any trading instrument available. They all have a history of success, but sound trading strategies have to be built around them according to individual trading goals.
Have fun making the trend, your friend!