The study of price trends is known as trend analysis. Understanding and using trend analysis is fundamental to successful trading.
Recognising and understanding price trends will enable you to identify potential trading opportunities, and to manage your risk effectively.
Here we’ll take a close look at price trend analysis, and show you a range of effective strategies for trend trading.
What is trend analysis?
Trend analysis definition
A trend describes the price movement of an asset that goes in one particular direction.
Therefore, trend analysis involves studying these trends to gain an insight into future price direction.
Price can only move one of three ways – either up, down or sideways.
Price action can follow a particular trend direction for hours, days or even months.
Then, something will happen that causes the trend to be broken.
The price will break out of the trend it’s been in, and will 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.
Market trend analysis
The reasons that prices break out of trends and change direction are many and complicated. The study of these reasons is known as market trend analysis.
These reasons are the ‘million-dollar answer’ that every retail trader would love to know in order to accurately undertake market trend analysis.
However, none of us has a crystal ball!
Sometimes the reason for price movement is obvious, such as a federal government announcement about monetary policy.
However, at other times, the reason for price movement is not so easy to see, which is why traders depend on trend analysis to come up with some answers.
Factors which may affect price movement include:
- a news item that affects buyer confidence
- a major announcement about interest rates or economic strength
- for commodity traders, it may be something natural that happens, a ‘force majeure’ such as a cyclone, typhoon, hurricane or volcanic eruption
How to do trend analysis
Price action can only go one of three ways – either up, down or sideways.
The example below shows price action in a bullish uptrend, and then a bearish downtrend, and then in a sideways range.
In general terms, price trends are all about the pressure between buyers and sellers, the bulls and bears.
- 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, the price often fluctuates within a relatively narrow range, without forming a clear trend direction.
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 trend analysis
There are three different elements of price trend analysis you should be aware of:
Price 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 of trend
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 of movement
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 reversal patterns and fluctuations. This can be seen on a price chart as a period of volatility.
Using candlestick patterns for market trend analysis
A close examination of candlestick chart patterns can help a trader determine how strong a trend may be.
Some candlestick patterns indicate a stronger conviction than others. For example, a long green candlestick, or several in a row, indicates a strong upward trend.
Several red candlesticks in a row indicates the opposite – a strong downtrend.
Here you can find out more information about forex chart patterns.
The significance of price in trend analysis
Price trends are important for three main reasons:
1. Identification of trading opportunities
Recognising and understanding price trends enables traders to identify potential trading opportunities. By aligning your positions with the prevailing trend direction, you can increase the likelihood of profitable trades.
Price trends also play a crucial role in risk management. Using trend-following indicators, you can set your stop-loss orders at a price that will limit potential losses in the case of a trend reversal.
3. Market Sentiment
The price of a forex pair reflects the collective sentiment of all market participants. This includes retail traders, investors, and institutions.
Careful market trend analysis can provide you with insights into market sentiment, and so help you to anticipate future price movements.
It’s is often said that ‘Mum and Dad traders’ (ie. retail traders) open the market, but professional traders close it.
Therefore, closing price is often given more weight than opening price 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 often 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:
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 price action represented with 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, as illustrated 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 price action represented by the Parabolic SAR indicator.
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
Parabolic SAR
In the example above, 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.
You can find out more about the 12 best indicators to use for forex trading here.
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:
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.
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 blue MACD line crosses below the signal line.
Here is an example of a bullish signal given when the blue MACD line crosses the signal line from below to indicate the start of an uptrend.
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 first 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 more about rules-based trading systems here.
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!
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Sources
Marketmates uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial guidelines to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
- Turtle Trader – Turtle Trader Rules https://www.turtletrader.com/rules/
- Richard Donchian – inventor of Donchian Channels https://en.wikipedia.org/wiki/Richard_Donchian
