Price does not trend all the time, it trends only 30% of the time so it becomes important for traders to spot these trends and trade them, so here are the top 5 trend riding indicators that you can use and start trading right away.
What are indicators?
Indicators are tools of technical analysis that traders use to make their trading decisions. These tools are basically a set of formulas and calculations that are mainly applied to the price and volume of the asset it is being applied on.
Now, I’ve mentioned that the market moves in phases, a consolidation or ranging phase and a trend phase which could either be an up trending or a down-trending movement.
The indicators that are available to traders are not built to cater to all types of market conditions or phases, some indicators will work best during a sideways price movement while some will work best when the market is trending.
The key here is to identify the type of phase the market is already in or is getting into and then apply the appropriate indicator to get trading signals.
In this blog post, I will talk about the top 5 indicators that you can use in a trending market and get good trade signals.
Trend riding indicators
RSI stands for Relative Strength Index. It is a technical indicator developed by J. Welles Wilder Jr. back in the year 1978 and traders utilize this tool even today to identify trading opportunities.
The RSI allows traders to gauge the momentum of the currency and determine how strong or weak the currency pair is. Once applied on a chart it is displayed either above or below the price chart.
This indicator is applied to the historical closing price of the currency pairs. Traders can choose the time period of the indicator and on which time frame to apply it. The default time period setting of the RSI is 14.
RSI is an oscillator indicator. It means that its value moves between an extreme point and a low point, where the extreme is 100 and the low is 0.
The calculation of the RSI is a tad bit complicated and technical and it is not something traders ponder over. What’s important here is to learn to use this indicator properly.
There are two ways you can use this indicator to trade currencies.
1. Overbought and oversold
The value of the RSI oscillates between 0 and 100 but traders consider 70 and 30 as the extreme points.
If the value of the RSI is above 70, then the currency is said to be in the overbought zone. And if the value of the RSI is below 30, then the currency is said to be in the oversold zone.
Some traders use 80 and 20 or 90 and 10 as extreme values. You have to decide what values work for you and the only way to decide this is by testing different settings.
If the price of currency moves into the overbought zone or the oversold zone, it doesn’t mean that traders would straight away short or long the currency respectively.
Even if the price is overbought or oversold according to the RSI, it could stay in those zones for some time before moving away from it.
One common strategy to trade these overbought and oversold zones of the RSI is to look for a bullish or bearish crossover.
A bullish crossover is when the value of the RSI moves above the oversold zone, a bearish crossover is when the value of the RSI moves below the overbought zone.
A bullish crossover indicates that price might have entered into an up-trending phase and that the buyers are taking over control.
Bearish crossover indicates that the price might see a decline where the sellers are gaining control.
Traders do not act on these signals standalone, they look to combine them with other strategies and look for additional confirmations or confluences.
Divergence is observed when the movement of the price does not match the movement of the value of the indicator or vice versa.
Since RSI is an indicator that is applied to the price of the currency, its values should to an extent move in the same manner as the price of the currency.
But it has been observed that at times when the price is advancing or declining, the value of the RSI declines or advances respectively. This is an anomaly that traders can make good use of to find trading opportunities.
Divergences could be of two types, bullish divergence, and bearish divergence.
Bullish divergence is when the price is making a lower low while the RSI enters the oversold zone followed by a higher low.
Traders interpret this as a potential reversal in the trend and can decide to go long on the currency pair once the value of the RSI moves above the oversold zone.
Bearish divergence is when the price is making a higher high while the RSI enters the overbought zone followed by a lower high.
This can also be seen as a potential reversal in trend can traders look to go short once the RSI value moves below the overbought zone.
MACD stands for Moving Average Convergence/Divergence. It is a technical tool that traders use to identify trend formation or momentum in the price of the currency pair.
It was created by Gerald Appel in the late 1970s and this indicator is still relevant in the financial markets today.
The MACD indicator basically represents a relationship between two moving averages, a 26-period exponential moving average and a 12-period exponential moving average.
The values of these two moving averages are subtracted and the resulting value is known as the MACD line.
A 9 period exponential moving average of the MACD line is then plotted and is known as the signal line. The signal line along with the MACD line help traders in identifying trade opportunities.
This indicator too is an oscillator but it does not have oversold or overbought zones. The MACD oscillates without any definite extreme boundaries.
The above-mentioned values are the default values of the MACD but you can always tweak it according to their requirements. You can also choose to apply this indicator to different timeframes.
There is also a baseline that is applied to the plotting of the MACD indicator at the zero level. The values of the MACD line and the signal line keep moving through this zero level.
MACD is often displayed along with a histogram which represents the distance between the MACD line and the signal line. The histogram is situated at the zero line.
If the MACD line is below the signal line then the histogram will consist of red bars and will be below the baseline or the zero level. The size of the bars of the histogram will be according to the distance between the MACD line and the signal line.
In the same way, if the MACD line is above the signal line then the histogram will consist of green bars and will be above the zero line. The size of the bars will again be according to the distance between the two lines.
Traders also use this histogram to gauge the strength of the price trend. Now that I have discussed the construction of the MACD, let’s move on to the practical application of the indicator.
1. MACD line and signal line crossover
We have seen the construction of the MACD and now know that it consists of a MACD line and a signal line. Traders look to enter into trades whenever there is a crossover between these two lines.
Now, the crossover can be of two types, bullish crossovers, and bearish crossovers.
Bullish crossover is when the MACD line crosses over the signal line. This indicates that the price of the currency pair might initiate an uptrend and traders are going long.
A bearish crossover is when the MACD line crosses below the signal line. This indicates that the price of the currency pair might enter into a downtrend and that sellers are gaining strength.
2. Baseline crossover
The baseline crossovers involve the MACD line and the baseline or the zero line are also of two types, bullish crossover, and bearish crossover.
A bullish crossover is when the MACD line crosses the baseline to the upside from below it, while a bearish crossover is when the MACD line crosses the baseline to the downside from above it.
The decline or advance of the MACD line is often caused because of the crossover of the 12 EMA and the 26 EMA.
Whenever the shorter EMA i.e. the 12 EMA crosses above or below the longer EMA i.e. 26 EMA, the MACD line rises or declines respectively.
Once the MACD line crosses above or below the baseline, traders identify this as a shift in momentum and look to trade the opportunity.
Divergence in the MACD indicator occurs when the MACD line’s movement is opposite to that of the price of the currency. Divergence in MACD is again of two types, bullish divergence, and bearish divergence.
Bullish divergence is when the price is making a lower low while the MACD line is making a higher high. This gives an indication that the price might see a reversal and can start an uptrend.
Bearish divergence in the MACD indicator occurs when the price makes a higher high while the MACD line makes a lower low. This is interpreted as a possible change in trend towards the downside.
III. Moving average
Moving average is one the simplest and most commonly used technical analysis tool. It is widely used by traders irrespective of their experience level in the market.
The construction of the moving averages is quite simple. It provides the average of the price over the past time period. Now, this time period can vary and traders can choose whatever time period they require an average of.
As and when new prices are formed additional data points are created and the moving average prints additional values. These averages are then connected to form a line.
Hence, the moving averages smoothen out price data by creating a constantly updating average price.
Moving averages are of different types depending on their time period, timeframe, and construction.
Traders can select the time period of which they require an average of, hence they can have multiple moving averages on the charts with different time periods.
Moving averages being a versatile technical analysis tool, can be applied to every possible timeframe.
Based on its construction, there are simple moving averages (SMA), exponential moving averages (EMA), and weighted moving averages (WMA). There are some more types of moving averages, but these are the commonly used ones.
The main use of moving averages is to reduce noise on the price chart and to get an idea of the prevailing trend of the price.
If the moving average is sloping upwards, then the price is said to be in an uptrend. If it is sloping downwards, then the price is said to be in a downtrend. If the moving averages are flat, then the price is consolidating.
There are mainly three ways that traders look to incorporate moving averages in their trading to look for trades.
1. Price and moving average crossover
We now know that traders use the moving average tool to identify the prevailing trend of the price and it allows them to take trade decisions accordingly. Moving averages also help trades to spot trend reversals.
Whenever price is in a trend, it usually moves away from the moving average. When the trend is losing strength, price is seen to move towards the moving average.
A change in trend can be confirmed when the price crosses the moving average. This can be of two types, bullish and bearish.
A bullish price and moving average crossover are when the price crosses the moving average to the upside from the downside.
A bearish price and moving average crossover are when the price crosses the moving average to the downside from the upside.
Traders do not take trades every time such crossover takes place, but rather it allows them to understand the nature of the trend. Traders then use different tools or methods to take trades.
2. Moving average crossover
In a moving average crossover strategy, traders plot a minimum of two moving averages on the price charts of the currency pairs. In this, one moving average is shorter i.e. of a lesser time period, and the other moving average is a longer one i.e. of a longer time period.
Moving average crossovers are of two types, bullish crossover, and bearish crossover.
A bullish crossover occurs when the shorter moving average crosses the longer moving average to the upside. This indicates that the current trend has reversed and the old trend is losing strength i.e. the buyers are taking control from the sellers.
A bearish crossover is one in which the shorter moving average crosses the longer moving average to the downside. Here, traders get an indication that the current trend is reversing and the price is entering a downtrend.
3. Support and resistance
Support and resistance are often considered to be straight horizontal lines or zones on the price charts of currency pairs. But moving averages are considered to be significant support and resistance areas.
It is often observed that once the price of a currency pair is in an uptrend and is well above the moving average, a pullback occurs where the price reaches the moving average and then bounces away from it and resumes the uptrend.
In the same way, when the price is in a downtrend and is well below the moving average, it reaches the moving average and bounces away from it and resumes the downtrend.
Moving averages being a sloping line and not a straight line, act as dynamic support and resistance. A large number of traders use moving averages and they look up to them as important price areas.
The rationale behind moving averages as support and resistance is that once price trends, it is difficult for it to keep continuing in the direction the entire time.
The price will see a pullback in the opposite direction, and when it does, traders look to get into trades and in the direction of the prevailing trend.
IV. Parabolic SAR
Parabolic SAR stands for parabolic stop and reverse. It is a technical analysis tool developed by J. Welles Wilder Jr.
It is a trend following indicator that allows traders to spot trend reversal which they can then be a part of from the beginning. There is a calculation and a formula of the indicator, but in this blog post, I will not dive into that part.
When the parabolic SAR is applied to a price chart, the indicator appears as a series of dots placed on top of or below the price or the candlesticks.
There is a default setting of the indicator, but traders can always tweak the setting as per their requirements.
If the indicator or the dots are below the price then it is a bullish indication and if it is above the price then it is a bearish indication. Traders use this indicator for spotting trade opportunities by looking for a flip of the dots.
A bullish flip will be when the dots were consistently above the price but then it gets printed below the price. This gives an indication of a change in trend, into bullish, as per the indicator.
A bearish flip will be when the dots being consistently below the price, get printed above it, thus indicating the possibility of a start of a bearish trend.
The dots that are printed above or below the candlesticks can be used to place stop losses too. Traders often place their stop loss at the price level at which the dots are printed and then trail the stop loss as and when they get printed as price moves.
If you apply this indicator to a price chart of currency pairs, you will notice that not all trades are good ones.
Hence, you will have to use this indicator along with other methods of analysis and then only take trades. This will ensure that you avoid bad trades and only capitalize on the good ones.
V. On Balance Volume
On balance volume is a technical indicator that helps traders to gauge momentum. This tool takes the volume into consideration. It was developed by Joseph Granville in the year 1963.
The OBV allows traders to quantify the volume in the trading sessions, it measures the buying and selling.
The OBV indicator has three rules,
i. If today’s close > yesterday’s close, then Current OBV = Previous OBV + Today’s volume.
ii. If today’s close < yesterday’s close, then Current OBV = Previous OBV - Today’s volume.
iii. If today’s close = yesterday’s close, then Current OBV = Previous OBV.
So, OBV is simply an indicator that adds up and subtracts volumes that were present in the trading sessions, that’s it? The main purpose of the OBV indicator is to distinguish between smart money and retail money.
Smart money usually looks to accumulate or increase its position without disturbing the stability of the price. While retail participants are reactors to an already initiated trend.
In this too, divergence comes into the picture. If the indicator’s value is creating a higher high while the price of the currency pair is creating a lower low, then it is an indication of a possible reversal and start of a bullish trend. This is a bullish divergence.
Bearish divergence is seen when the value of the indicator prints a lower low while price of the currency pair is creating a higher high, then there is a possibility of a reversal and that the price can start declining.
It should be noted that the actual value of the OBV indicator does not have much significance. The value is basically cumulative of several trading sessions.
During peak hours or during any news events, there might be a spike in volume and it might destabilize the OBV because of block orders. Hence, traders should not necessarily track the exact value of OBV.
But the thing that traders must look at is the nature of the value line and the manner in which it is moving.
Which indicator is the best?
I have now discussed the top 5 technical indicators that you can use to spot a trend in its initial phase and ride it till it lasts. But out of the 5, which one is the best?
I cannot give you a definite answer and it should be noted that the order in which these indicators have been listed has no significance whatsoever. The best way to know which indicator works best for you is to try all of them and then decide for yourself.
I have given you some methods and strategies that you can look to use and can test these on past data and also paper trade in the live market and then compare the indicators accordingly.
The fact that there are so many indicators available, indicates that no single indicator works best. Different traders developed different indicators in order to make things easier for them in trading.
One thing to note is that most of the indicators that are available out there are lagging indicators i.e. they print a value after the price has already moved. They only represent what price has done in the past and not what it will do in the future.
The exception here is the OBV, which is considered to be a leading indicator as it takes volume into consideration. This may lead to unnecessary predictions.
What I intend to convey through this is that no indicator will work every time and that no indicator should be used standalone. It is always advised to use the indicators along with other tools for additional confirmation and confluence.
But it should also be noted that do not cram the chart with numerous indicators or else you will become prey to analysis paralysis as at any given time different indicators will give different signals.
Hence, you must work out what is best for you only after trying everything out and do not forget to keep things easy and simple.
Which indicator are you going to use?
Which one of these 5 trend riding indicators are you going to use to capitalize on the price swings in the forex market? Do let me know.
If there’s any other trend riding indicator you use that hasn’t been covered in this blog post, let me know in the comments section.
Don’t forget to share this blog post with every trader you know and let them also take advantage of these amazing indicators.
Feel free to drop in your questions or queries in the comments section and I will get back to it at the earliest.