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Last updated on May 22nd, 2024
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Cate Cook

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Cate Cook
Cate is a journalist by profession who started trading shares in 2008, after which she became a full time CFD day trader for more than 10 years. She now combines her passions for writing and trading at MarketMates. Join the blog to receive the latest articles from Cate.
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Sam Eder

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Sam Eder
Sam is the Cofounder and CEO of MarketMates. He has traded since 2008 and is the Author of the Amazon best-seller The Consistent Trader. Over 42,000 traders have taken his Advanced Forex Course for Smart Traders. Join the blog to get his latest articles.
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Trend Analysis and Trend Trading Strategies

Learn how to recognise trends and use effective trend trading strategies to give your trading an edge

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In this article

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At MarketMates, we are committed to providing accurate information. Our content undergoes a rigorous process of fact-checking before it is published. Learn more about our editorial policy.

In this article

Understanding price trends is fundamental to successful trading. 

Trends are a key concept in technical analysis, which involves analysing historical price data to forecast future price movements.   

Recognising and understanding price trends enables traders to identify potential trading opportunities and to manage risk effectively. 

In this lesson, we look at price trend analysis, and give you a range of effective strategies for trading trends.

Trend Trading Analysis

A trend describes the price movement of an asset that goes in one particular direction.

This can be one of three ways – either up, down or sideways.

Price action can follow a particular trend for hours, days or even months.

Then, something will happen that causes the trend to be broken, and the price will break out of the trend it has been in, and potentially move quickly in another direction, before settling into a new trend.

This pattern repeats itself over and over again, regardless of what type of asset you are trading.

Reasons for trend direction change

The reasons that prices break out of trends and change direction are many, and complicated.

In some ways, that is the million-dollar question that every trader would love to know!

Factors could include:

  • a news item that affects buyer confidence
  • a major announcement about interest rates or economic strength
  • if you are trading commodities, it may be something natural that happens, a ‘force majeure’ such as a cyclone, typhoon or volcanic eruption

Price action can only go one of three ways – either up, down or sideways. The example below shows price action trending sideways, then a downtrend, followed by an uptrend.

Price action

In general terms, price trends are all about the pressure between buyers and sellers.

  • During upward trends, the bulls (buyers) are in charge
  • During downtrends, the bears (sellers) are in charge
  • If price ranges sideways, then the asset is said to be in a period of consolidation, when neither bulls nor bears are dominant

In a sideways trend, prices often fluctuate within a relatively narrow range, without forming a clear trend direction.

Trend breakout

Price action often bounces between support and resistance lines, before breaking out of that pattern and starting a new trend in a clear direction.

Key elements of price trends

There are three different elements of price trends you should take note of:

Direction: As mentioned above, a price trend can be either upward (bullish), downward (bearish), or sideways (consolidation).

In an uptrend, prices consistently make higher highs and higher lows, while in a downtrend, prices make lower lows and lower highs.

Sideways trends occur when prices move within well-defined levels of support and resistance.

Although there might be occasional breaches of these levels, they’re often short-lived and lack the momentum to establish new highs or lows.

It’s common for prices to linger in a horizontal pattern for an extended period before resuming their previous trend, or initiating a new one.

When there’s no distinct directional movement, sideways trends can prove frustrating for short-term traders and those who follow trends.

Duration: Price trends vary in duration, ranging from short-term trends that last for minutes or hours, days or weeks, to long-term trends that persist for weeks or months.

The duration of a trend can impact its significance and the trading strategies employed to capitalise on it.

The longer that price action has remained in one direction, the more radical that movement tends to be when a breakout occurs and the direction changes.

Strength: The strength of a price trend refers to the degree of conviction behind the trend movement.

A strong trend is characterised by consistent price movement in the trend direction, with minimal retracements or pullbacks.

A weak trend may exhibit more frequent reversals and fluctuations. This can be seen on a price chart as a period of volatility.

Using candlesticks patterns to determine the strength of a trend

A close examination of candlestick shapes can help a trader determine how strong the trend may be, with some candlestick patterns indicating stronger conviction than others.

For more information about candlestick shapes, see our lesson all about candlestick patterns and what they say about price action.

The significance of price trends

Price trends are important for three main reasons:

Identification of trading opportunities: Recognising and understanding price trends enables traders to identify potential trading opportunities. By aligning their positions with the prevailing trend direction, traders can increase the likelihood of profitable trades.

Risk Management: Price trends also play a crucial role in risk management. Traders often incorporate trend-following indicators and use these to set their stop-loss orders to limit potential losses in the case of a trend reversal.

Market Sentiment: Price trends reflect the collective sentiment of market participants, including retail traders, investors, and institutions. Analysing trends can provide insights into market sentiment and help anticipate future price movements.

It’s is often said that ‘Mum and Dad traders’ open the market, but professional traders close it.

Therefore, closing price is often given more weight than opening price when analysing trends.

Indicators to help you identify price trends

Different chart timeframes require different approaches to trend identification.

For example, if you are a short-term day trader looking at second or minute charts, you’ll require a more sensitive trend indicator than if you are looking at daily or weekly charts, intending to trade over a longer period.

However, no matter what style of trading you do, or what system you use, it’s always a good idea to look at several different chart timeframes when determining trend direction.

Restricting your view of price action to just one timeframe can give you a false impression of overall trend direction.

For example, looking at a 15-minute chart may show you that price action is falling, implying a short trade.

However, if you then change your view to a daily chart, you may find the asset has been in a sustained uptrend for several days.

In this case, a temporary pullback of price during a trading session (as shown on the 15-minute chart) would give you a false impression of overall price direction.

For this reason, I’d suggest you use different trend indicators depending on the timeframe you are interested in as a trader.

I’m going to break indicators into two categories:

  • Higher timeframes: those indicators that are great to use for higher timeframes, such daily or weekly charts
  • Lower timeframes: those indicators that are useful for shorter-term timeframes, such as minute or hourly charts

When I was day-trading stock CFDs, I would use two simple moving average (SMA) indicators to give me trend direction information.

My colleague Sam, who is a forex trader, prefers to use Bollinger Bands and the Supertrend indicator for his trading.

Trend analysis indicators to use for higher timeframes

For higher timeframes, such as daily or weekly charts, you can use indicators like:

  • Supertrend
  • Bollinger Bands
  • Parabolic SAR

to identify long-term trends and potential reversal points.

These indicators provide a broad view of price movements, and are ideal for swing and position traders looking to capture larger price swings.

Supertrend

This indicator plots a trend-following line above or below the price, indicating the direction of the trend.

A bullish trend is signalled when the price is above the Supertrend line, while a bearish trend is indicated when price is below the line.

Here’s an example of what the Supertrend indicator looks like:

Supertrend indicator

Bearish trend movement is coloured red, while bullish movement is coloured green.

This indicator makes it very clear which direction the trend is moving in.

Bollinger Bands:

These bands consist of a simple moving average (SMA) and two standard deviation bands above and below the SMA.

Narrowing bands indicate low volatility, while widening bands suggest increasing volatility.

Price movements outside the bands can signal potential trend reversals.

This example shows the same price action represented with Bollinger Bands.

Bollinger Bands

In addition to indicating trend direction and volatility, Bollinger Bands also indicate when an asset may become overbought or oversold.

This is indicated by the price moving outside of the upper or lower band (the lower band in the example above.)

Parabolic SAR

This indicator places dots above or below the price, indicating potential reversal points.

  • Price action above the dots suggests an uptrend is happening
  • Price action below the dots suggests a downtrend

When the dots switch from being below to above the price candlesticks, it signals a potential shift from an uptrend to a downtrend, and vice versa.

Here is the exact same price action represented by the Parabolic SAR indicator.

 

Parabolic SAR

Comparing the Supertrend indicator and the Parabolic SAR, did you notice how the Supertrend indicator is quicker to respond to the trend change direction, and so therefore is more sensitive or potentially more accurate?

 

Supertrend

Supertrend example with SAR

Parabolic SAR

SAR indicator with Supertrend

 

In this example, showing identical price action:

  • the Supertrend indicator changes from green to red (bullish to bearish) at the second red candlestick of the new downtrend, signalling a trend reversal
  • however, the Parabolic SAR does not show a change of trend direction until the fourth candlestick of the new downtrend

It is up to you which indicator you choose to use to give you a greater understanding of price trend.

However, my advice is to choose one indicator, get to know how it works intimately, and stick to it.

Don’t make the mistake that many new traders make of displaying multiple indicators on your price charts.

This will only result in confusion and indecision.

Recommendations for lower timeframes

If you are trading using a lower timeframe, such as minute, hourly or four-hourly charts, it can be a good idea to use moving average-based indicators to give you a more precise view of trend direction.

I like to use Moving Averages (MAs) and the MACD indicator for shorter timeframes.

Moving Averages (MAs):

MAs smooth out price data to identify the underlying trend direction.

  • a bullish trend is signalled when the shorter-term MA crosses above the longer-term MA
  • a bearish trend is indicated when the shorter-term MA crosses below the longer-term MA.

When I was trading, I used a MA crossover of the 20-day MA and the 5-day MA as an entry signal. I found this provided a really accurate trend change signal which I was able to successfully day trade.

For example, here is a ‘Golden Crossover’ when the shorter red 5-day MA crosses the longer blue 20-day MA from below, signalling the start of an uptrend:

Moving average Golden Crossover

And here is the reverse – a Graveyard Crossover, where the 20-day MA is crossed by the 5-day MA from above, signalling the start of a downtrend.

Moving average Graveyard Crossover

 

With both these examples, viewed on a four-hourly chart, the MAs gave a very accurate indicator of trend change as soon as the crossover took place.

This is why I used this particular indicator set-up when I was day-trading stock CFDs and making multiple trade entries and exits a day.

MACD

This indicator consists of two lines – the MACD line (the blue line) and the signal line (the yellow line) – and a histogram.

  • Bullish signals occur when the blue MACD line crosses above the yellow signal line, indicating increasing bullish momentum.
  • Conversely, bearish signals occur when the MACD line crosses below the signal line.

Here is an example of the MACD line crossing the signal line to indicate the start of an uptrend, and then crossing back down when a downtrend started:

MACD indicator

Which trend indicators did the famous Turtle Traders use?

The Turtle Traders were a group of new traders coached by famous trader Richard Dennis and his friend William Eckhardt in the early 1980s.

Their story started with a bet between Dennis and Eckhardt about whether great traders were born, or whether trading skills could be taught.

To test this, they trained a group of novice traders and gave them a rules-based trading system to use, to see if they could do well in the markets.

These traders became known as the Turtle Traders.

The experiment was a remarkable success, as many of the Turtle Traders went on to achieve significant success in the financial markets.

It proved that successful traders can be taught.

Donchian Channels

The Turtles were allowed to use two different trade entry signals based on trend breakouts.

They used channel breakouts using the Donchian Channel indicator.

  • System 1 – A shorter-term system based on a 20-day breakout
  • System 2 – A simpler long-term system based on a 55-day breakout.

They defined a trend breakout as being when the price exceeded the high or low of a particular number of days.

Therefore, a 20-day breakout would be defined as exceeding the high or low of the preceding 20 days.

Here’s an example of a trend breakout using the Donchian Channel indicator set to a 20-day period. The breakout occurs when the long green candlestick breaks above the upper horizontal Donchian Channel line:

The Turtles entered a trade based on when the breakout occurred, and did not wait for confirmation the following day.

In The Original Turtle Rules, which you can read here, their entry system is described like this:

“Turtles entered positions when the price exceeded by a single tick the high or low of the preceding 20 days.

If the price exceeded the 20-day high, then the Turtles would buy one unit to initiate a long position in the corresponding commodity.”

Remember that the Turtles were trading using a comprehensive rules-based trading system.

You can learn all about a rules-based trading system through The Advanced Forex Course for Smart Traders 2.0.

As a new trader, you can use any of the indicators described above to enter your trades.

However, remember that your trade entry point is not the most important decision you need to make as a trader.

Position size and risk management are more important factors to get right if you wish to become a successful and profitable trader over the long term.

Until next time, happy trading!

Cate

Get this week's best trading content

Lessons for all levels of trader. Nail the basics, master your mindset and learn advanced techniques.

Cate Cook

Cate Cook

Cate is a journalist by profession who started trading shares in 2008, after which she became a fulltime CFD day trader for more than 10 years. She now combines her passions for writing and trading at MarketMates. Join the blog to get the latest articles from Cate.
Cate Cook

Cate Cook

Cate is a journalist by profession who started trading shares in 2008, after which she became a fulltime CFD day trader for more than 10 years. She now combines her passions for writing and trading at MarketMates. Join the blog to get the latest articles from Cate.

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© 2024 – MarketMates.
All rights reserved | Privacy Policy | Risk Disclosure

General Advice Warning: From time to time, you may receive general non-binding advice from us. This information is intended to be general and is not personal financial product advice. It does not take into account your objectives, financial situation, or needs. Before acting on any information, you should consider the appropriateness of the information provided and the nature of the relevant financial product having regard to your objectives, financial situation, and needs. MarketMates is not liable for or held responsible for any loss, financial or otherwise in relation to information received from MarketMates.

© 2024 – MarketMates.
All rights reserved | Privacy Policy | Risk Disclosure

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