“The trend is your friend.” It’s the oldest and most repeated adage in trading, and it’s beaten to death for one simple reason: It’s right. The strongest, most profitable market action happens when a stock starts to develop long-term directional opinions. Going to war against it is a surefire recipe for frustration and defeat; riding it is the path of least resistance to profitability.
But how do you recognize a trend objectively and confirm its strength, the perfect time to join it? You need a reliable toolkit. Using your gut or a single indicator is a roll of the dice. But trend-following as a systematic strategy turns it into anything but a cliché.
In this article, we describe five key indicators that make up the strong trend trading methods toolbox. Together, these tools collaborate to answer the three most important questions any trend trader should ask themselves: Which way is the trend going? Is the strong trend healthy? Where is the best place to come on board?
The Trend’s Foundation: The Moving Average
Trend Identification Moving averages are the cornerstone of trend determination. By filtering out noise they make it easier to identify the market’s trend.
How to Use It:
For follow-the-trend, they are aimed at removing the short-term fluctuation and concentrating on the long-term trend. Perhaps the most popular and simple method for this is a dual moving average crossover system.
The 50-period and 200-period EMA crossover is a classic.
Trend Direction: Trend is up when the 50 EMA is above the 200 EMA. If the 50 EMA is less than the 200 EMA, it is a downtrend.
The “Golden Cross” & “Death Cross”: Marking the point when the 50 EMA cuts over the 200 EMA it is a bullish ” Golden Cross”. When that line crosses below, it’s a bearish “Death Cross.” These are powerful, long-term confirmations of a trend reversal.
Why It Matters: Moving averages will afford you a clear, objective line in the sand. Bull Market- Price above a rising 200 EMA. Bear market: When price action is below a sloping down 200 EMA. It takes away the guesswork, and keeps you on the right side of the big move.
The MACD: A Trend’s Momentum Indicator
The workhorse of the trend-following toolbox is Moving Average Convergence Divergence (MACD). While moving averages show you the direction a trend is headed in, the MACD can offer indication of how strong its momentum is.
How to Use It:
It is composed of two lines – the MACD line and Signal line – and a histogram.
Confirmation of Trends: The simplest signal is to look for the MACD Line to be above the Signal Line in an uptrend or below it in a downtrend.
The True Power – Centerline Crossovers:The best signal a trend trader can receive from the MACD is when it crosses above the 0 line and goes positive confirming a bullish move. Below of the zero value, the crossing confirms downwards pressure. At any rate, this is a much more powerful signal than the line crossings that provide signals throughout a sideways market.
Histogram: The bars on the histogram indicate the separation between the MACD and Signal line. As the bars are growing in size, it tells you momentum is picking up. Decreasing bars signify that momentum is slowing, and may indicate an associated pullback.
Why It’s Important: The MACD keeps you from potentially entering a trend just as it is dissipating. As is a bullish moving average crossover, which will make much more sense if it has combined with a good MACD crossover above zero.
The Average Directional Index (ADX): The Strength of the Trend
This is the most misconceived and specialized tool in the bag. The direction of the trend is not indicated by the ADX. Any way it is a number to solely measure the strength of the trend.
How to Use It:
The ADX is a one-liner which merely fluctuates from 0-100.
ADX above 25 signifies a strong and worthwhile trend.
An ADX of less than 20 indicates a weak or trading market.
An increase in ADX is a sign that the trend is gaining strength.
A declining ADX shows that the current trend is losing its strength, despite the highs/lows still being made by price.
Why It’s Important: ADX is your filtration.” It shows you when it makes sense to trade the trend and when you should just sit on your hands. A “Golden Cross” with an ADX of 15 would tend to be a head fake. A “Golden Cross” combined with an ADX greater than 25 indicates that there’s likely some real horsepower a new or established trend. It saves you from the choppy, whipsaw prone action that destroys trend-following strategies.
Bollinger Bands®:The Trend Is Your Compass
In a ranging environment the Bollinger Bands serve as dynamic support and resistance. But in a trending market, they have an entirely different, no less crucial role to play: they chart the trend’s course and show continuation patterns.
How to Use It:
“Walking the Bands” Phenomenon: In a dominating trend, the price typically will “walk” on the top band in an uptrend or bottom band in a downtrend. This is not an indication of being overbought and set to reverse, but one of extraordinary strength. The trend is so strong that it doesn’t even pull back to the mid band (20 period SMA).
Spotting Pullbacks: The best use of Bollinger Bands for a trending north star is to search for low-risk entries. In an uptrend, a pullback to the middle band (20 sma) on light volume is a sign that the stock is pulling back after it’s broken out, and has shown you at during its break higher so far.
Why It’s Important: Bollinger Bands give you the confidence to stay in a strong trending market and offer perspective on where an ideal place for adding into, or entering after a shallow pullback is so that you don’t end up buying a top.
The On-Balance Volume (OBV): A Measure of The Trend’s Strength
Price is easier to manipulate in the short term, but volume is far more difficult to fake. The On-Balance Volume indicator helps us see if a trend is being forced by real buying and selling pressure (also known as the “smart money”).
How to Use It:
OBV is volume that’s been totalled up over a series of candles. On up days, it adds volume; on down days, subtracts.
Trend Confirmation In an established uptrend, prices are making higher highs and the OBV line should also be making higher highs. This further verifies that volume is expanding on rallies and retracting on pullbacks. In a bearish trend, the OBV would be declining.
Divergence Warning:When the price moves to a new high while the OBV makes a lower high (bearish divergence), this gives a major warning that the trend is not being supported by volume and will probably start rapidly weakening.
Why It’s Important: OBV is your reality check. It validates that the movement you witness on price charts is genuine and has institutions behind it. A confirming OBV trend is a trend you can believe in.
Implementation of the Toolkit: A Comprehensive Approach
These are not to be used in isolation. They’re a powerful, interlocking machine.
Trend and Signals: I use the 50/2004 EMA crossover to determine a long-term trend. Only take a trade in the direction of this trend.
Validate the Power and Direction of Current Trends: Confirm the trend by using ADX. Is it above 25? Check the MACD. Is it on the right side of its zero line? If yes, the trend is strong.
Get Your Entry: Look for a pullback. Look for a pullback to the middle band using Bollinger Bands. C) Check the MACD if momentum is still bullish/bearish on a smaller TF.
Confirm with Volume: When the price is bouncing from a pullback look as well on the OBV. Is it agreeing with the move by going up (in an uptrend)?
Concluding: Trade with the Tide, Not Against It
Trend following is not about picking the magical top or bottom. It is recognizing, in a systematic way, that a move exists early enough to be able to make it confirmable and then riding it until the weight of evidence implies it’s over. When you develop your trading approach around these five critical indicators, you eliminate hope and guesswork by applying a disciplined, probabilities-based method.
You’ll be able to separate a real, strong trend from a false, erratic signal. You’ll know when to push, and when to be patient. Get this toolkit, and you will be on your road to making this trend be your most profitable friend.