In previous installments we have been going over the characteristics of a solid trading strategy. We have already covered picking your time frame. Today is about figuring out the overall trend direction or trend bias. The goal is to find the direction you want to trade in for the best possibility of success.
First, I want to say that no matter what your trading strategy, it is important to know the overall trend direction, or if there is a strong trend at all.
- If your trading strategy is a trend following strategy, knowing the trend direction tells you what direction to take trades. Obviously, you want to increase your chances of success by only taking trades in the direction of the trend.
- If your strategy is a counter-trend strategy, where you trade against the trend, you still need to know the trend direction. After all, how can you trade against the trend if you don’t know the direction of the trend in the first place?
- The only time trend direction is not that important is when you use a straddle type strategy where you place both a pending BUY order and pending SELL order at the same time. In this case, you don’t care which direction price moves, only that it moves with enough momentum to trigger your trade and hit your take profit.
Ways To Determine Trend Direction
Visual: The easiest way to see if there is a trend or not is to simply look at the charts. If price action is moving in an up direction, there is an up trend. If price action is moving in a down direction, there is a down trend. If price is moving sideways, you are in a consolidation, range bound market.
Trendlines: Drawing a trendline is another great way to determine trend direction.
- When you have higher lows, you connect the lows and see and uptrend.
- When you have lower highs, you connect the highs and see a downtrend.
- When you have the break of the trendline, there is a possible trend reversal.
Moving Averages: Putting moving averages on your charts is a common way to determine trend direction. You can either use moving averages alone, or combine different moving averages. The combinations of moving averages are endless. Here are a some I like:
Single Moving Averages and Price: 50 MA and 200 MA.
- For example, when price is above the 50 MA, your bias is up. When below, down.
- For a longer term view of the market, the 200 MA could be used.
2 Moving Average Combo: 10 EMA and 21 EMA. I like this on the Daily charts to see overall trend bias.
- When the 10 EMA crosses the 21 EMA, there is a possible trend bias change in the direction of the cross.
3 Moving Average Combination: 14 EMA, 6EMA and 4 EMA.
- When the 4 EMA is above the 6 EMA which is above the 14 EMA, your trend bias is up.
- When the 4 EMA is below the 6 EMA which is below the 14 EMA, your trend bias is down.
Other Indicators: There are a whole bunch of other indicators to help you determine trend direction or trend bias. For example, the MACD and RSI. Andrew Selby wrote recently about combining the 200 SMA with the MACD. There are also a lot of custom indicators claiming to determine the direction of the trend. Any one of these could be used.
Caution: It is very easy to get caught up into trying to find the perfect combination of indicators. All this does is crowd your charts and create confusion when trying to make a trading decision. The point is to use an indicator to give you an idea of the current trend direction so you can search for trading opportunities in that direction.
Trend Direction And Expert Advisors
Since we are primarily talking about automating your trading strategy into an expert advisor, there are some methods that work better than others. After all, the method you choose needs to be able to be programmed.
Determining trend direction should be a part of your trading strategy. There needs to be something in place to determine if the trend is up, down or sideways. Depending on the direction (or lack of direction), the rules of your strategy need to react in a certain way.
So far we have talked about picking a time frame and figuring out how to determine trend direction. This sparked a topic I want to talk about next time: How To Use Higher Time Frames And Trend Direction To Filter Your Trades. This kind of filter is something you should consider adding to your trading strategy and programming into your expert advisor.
What tools or techniques do you use to identify trends?
Read the next article in the series: How To Use Higher Time Frames And Trend Direction To Filter Your Trades