by Amanda Harvey
Trend indicators, as the name implies, are indicators which provide insight into whether a trend is may be about to develop, is already in progress or is nearing its end. These indicators may also be used to measure the strength of a trend.
Trend indicators are very useful to a trader, as direction of a trend is a vital piece of information for making trading choices. We have all heard the old adage that “the trend is your friend,” which make these indicators the equivalent of that friend’s Facebook page and Twitter feed – they can provide a very good idea of what your friend is up to.
How do Trend Indicators Work?
Sometimes it can be difficult to spot a trend by simply looking at charts. The markets experience volatility which causes the prices of a stock to fluctuate. Some indicators, like Moving Averages, work by applying a smoothing process to the price line, which allows the trader to see the trend beneath the ups and downs in price movement. Some indicators, such as Bollinger Bands, use a Moving average in combination with other lines created using standard deviations to produce a trend range. There are also indicators that use various calculations to assess trend strength and likelihood of a reversal.
What Are Some Popular Trend Indicators?
How to Effectively Use Trend Indicators
- Moving Averages is a simple and commonly used indicator that calculates the average of prices over a certain period of time, allowing the movement of the trend to be distinguished from the fluctuations.
- The Moving Average Convergence Divergence (MACD)
is used to spot changes in the strength, direction, momentum, and duration of a trend in a stock's price.
- Bollinger Bands are often used to anticipate trend reversals as the price nears the upper or lower lines. These two lines or “bands” are plotted above and below a moving average.
- The Average Directional Movement Index (ADX) is used to determine the strength of a trend. This indicator is also a component of the three-part system designed by Welles Wilder, known as the Directional Movement System.
- The Positive Direction Indicator (+DI) is another part of the Directional Movement System and is used to determine an upward trend.
- The Negative Direction Indicator (-DI) is the third element of the Directional Movement System and is used to establish a downward trend.
- The Mass Index uses the high and low stock prices during a set period to ascertain a likely point at which a trend reversal will occur.
When studying an indicator such as a Moving Average, there are several points which can help a trader to read the signals as accurately as possible. The first factor that determines a trend is likely to be in progress is that the actual stock price touches the indicator line a minimum of three times.
Secondly, the grade of the slope provides important information. An incline or decline that is very steep is less likely to be sustainable. On the contrary, a line that is too flat may not indicate a sufficient trend to make following it worthwhile. Ideally the line should have a moderate slope that allows momentum to continue.
It is also important to study a sufficient time period in order to identify a genuinely established trend. Furthermore, corroboration should be sought by the use of other indicators. Increased volume can also provide confirmation of the trend, as an uptrend will attract more buyers, and a downtrend will encourage a larger volume of selling at increasingly lower prices by traders attempting to cut their losses.
Trend indicators are a very valuable tool for traders wishing to join the momentum of market direction. They can help identify how long a trend is likely to continue, how strong the trend is, and when a reversal may be expected.
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