Winning in financial markets depends on experience, knowledge and a bit of good luck. However, trading in financial markets is far from gambling and is more like in-depth analysis, overall research, and using the right technical indicators.
Technical indicators are supportive tools that help you better read and understand charts and identify price action. Experienced traders use these tools to reveal underlying market dynamics and draw potential price directions.
Using indicators can be confusing because there are plenty of them, and it is recommended that you use the right one, depending on your trading strategy. Today, we will talk about the right indicators that you can use with trend trading.
What is Trend Trading?
Before we dive into trend indicators, let’s explain what trend trading is.
Trend trading is identifying prolonged periods of price movements and capitalising on those opportunities by executing the right market order, buy or sell. It is one of the most common trading strategies, benefiting from market dynamics and the fact that prices fluctuate in opposite directions.
For example, a trader analyses the market with the right signals and predicts a potential positive price movement in the coming couple of days at an increasing growth rate. This represents an upward trend, representing an excellent chance to execute buy order(s) and watch the price pick up, increasing the order value.
The trader from the above example can sell after they reach a price level that is sufficient for them to make enough profit or keep it in the hopes of maximising gains more and more.
Similarly, a trader can capitalise on a possible downward trend and short stocks and keep the position just before the market price reverses.
However, identifying trends is not an easy task because prices move constantly, and it is very easy to misunderstand a certain price action, for example, if a stock goes up briefly just before a massive decline. This overestimation can lead to excessive losses.
Trend Trading Indicators
There are several reasons why a certain market or asset would move in a particular direction. These include internal factors like company performance, equity and cash flow reports, and whistleblower news.
External factors can also impact the market in times of economic crisis, natural disasters and geopolitical events and announcements.
These technical indicators help traders locate and track price movement and what it means, whether a potential steady trend or a short-term fluctuation.
Traders use trend technical indicators in a combination of different time periods or by merging a few indicators together to have a more accurate view of the market.
Bollinger Band Indicator
The Bollinger Band indicator is a commonly used way to detect outliers and understand market price movements based on the standard deviation. Thus, the BB indicator tells how a market price deviates from its average and the possibilities for it to return to previous levels.
The Bollinger Bands work by drawing three lines along the chart: an upper line, a lower line, and a middle line on the average price. These lines are called bands, hence the name Bollinger bands.
These three bands draw an estimation of possible price movement in current and future times, and any movement outside these bands is more likely to be an outlier move, which will return inside the bands in no time.
For example, if the price drops towards the lower band and crosses it, it means that the asset is oversold, and it is a matter of time before it regains its value back to previous levels.
Moving Average Convergence Divergence Indicator
The moving average convergence divergence is a technical indicator that predicts possible trends based on historical price actions.
The MACS indicator uses multiple combinations like the exponential moving averages, which compare different periods in the past, comparing them against each other and against current price movements.
A common way to use this indicator is to compare short-term against long-term historical prices, like 10-day against 100-day, and track their movement with the current market price.
When the market price intercepts with the 10-day EMA line, it can indicate a possible future trend, depending on the line direction. However, if the current price crosses an older time period, like 100-day or 200-day, it may indicate a stronger trend.
Relative Strength Index Indicator
The RSI analyses previous price movements and fluctuation frequencies to predict if an asset is being overbought or oversold.
Therefore, it gives buy or sell signals that dictate to the trader the best course of action based on the RSI score it shows on the chart.
- RSI > 70; asset is overbought, sell order
- RSI < 30; asset is oversold, buy order.
Conclusion
Trend indicators give traders a clearer image and reasons behind a certain market movement, using historical market data and frequency of changes to provide buy or sell signals.
Some indicators work by detecting outliers and providing insights into the best entry and exit levels, like Bollinger bands and the relative strength index. On the other hand, the MACD indicator works by comparing previous against current price movements to identify possible trends.
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