Trend Analysis For Short Term Traders

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Trend Analysis For Short Term Traders

Trend analysis is a very valuable tool and at the heart of many strategies in use today. In a previous article, Introduction To Trend Analysis, I described the underlying trends that drive the markets such as the secular, primary and secondary trends. The secular trend is a measure of the economy and society as a whole and covers many years, usually 10 to 15. The primary trend is much shorter, only 3-5 years, and measures a more current view of how “things” are in the market. Let’s face it though, both of these trends are just about useless for a binary trader except in an academic sense. It is important to understand them, know what they means and keep them in mind when analyzing charts but how many signals do you get from the secular and long term trend each year? Not very many. I know that most of you out there are trading super short term 60 seconds (not recommended) and other near term options like 15 minute, one hour and end of the day. Trend analysis is just as important to you as to any other trader, you just have to apply it correctly.

The thing to keep in mind about the secular and long term trends is that they can often and usually do act as barriers, extremes and boundaries for the more mundane week to week and day to day movements of the market. This is why it is so important to understand trend from the top down. I always start my analysis from the weekly, sometimes monthly charts in order to keep things in perspective and often refer back to them to be sure by logic is sound.

Questions to consider include;Is the market moving up or down along or near a long term trend line, support line or resistance? What does the moving average look like? Is price over or under the moving average? All questions relevant for the shorter term day trader as well as the long term investor. As a day trader, if prices are bouncing from a confirmed area of long term support on a daily or weekly chart then I would assume that the trend is up, in a shorter time frame. The same is true if prices are moving down from resistance in a long term downtrend. Look at the chart below. After the USD/CHF break the first short term secondary trend line it confirms support with a nice trio of candles. This is a signal for a short term trader to begin looking for signals on a shorter term chart. This signal to look for signals is good until the asset prices meets resistance.

Looking above you can see that the short term trend and the daily chart give off only one or two signals on it’s own between the support confirmation of early May and when price reaches resistance later that month. Looking below you can see that a savvy day trader could have made several, if not dozens, of entries in that time using a shorter time frame chart. This is a chart of 30 minute closing, you can use one hour, 4 hour or 15 minute if you like, the point is to harness the power of longer term trends with a shorter term time frame. In my example I simply use a 30 bar EMA for entries and came up with nearly two dozen before I stopped counting. Any and all types of analysis can be used on the market in this time frame to gain signals once you establish the parameters of the trade. What the general direction is, where price is moving from and where it is moving to.

In this next chart I take the analysis a step further with the addition of near term trend lines, support and resistance. The addition of these lines helps to pinpoint the best entries on the 30 minute chart and even sets up additional entries not found with the moving average along. Not only that, the chart can now be adjusted to an even shorter time frame such as 15 or 5 minutes to achieve even more, shorter term, entries. The rule is to use the longer term charts to set parameters of your trade such as where the limits of a movement might be, whether a limit is being tested or broken and what direction prices are moving in while between two limits and then to use those parameters to help find trades in shorter time frames.

Expiry And Time Frame

Each time you take a step down in time frame you need to adjust your expiry to match. The key to pinpointing expiry lies with the trend and the time frame. How many bars does it take for the average signal to move into the money? This number, times the length of the candle or bar is one good way to choose. On the charts here, 30 minute charts, most of the signal move into the money within one or two candles so expiry of 30 minutes to one hour up to 4 hours or even end of the day would be OK, depending on the signal and its relation to near, short and long term resistance.

Advance Decline Line For Swing Trading

Different Approach To Stock Market Trend Analysis When traders first start out they typically follow the standard approach to stock market trend analysis.

Most traders rely on basic indicators such as moving averages and oscillators to determine if the stock market is trending, how strong the current trend is and whether or not the market is approaching overbought and oversold levels as well.

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While these basic technical indicators provide important data about past market behavior, there are some indicators that can give you a broad picture of what the short term future has in store for stock market prices.

The NYSE Advance Decline Line The Advance Decline Line also known as AD Line is a market breadth indicator that is based on the Net Advancing stocks, this is the number of advancing stocks less the number of declining stocks.

The Net Advances is a positive number when there are more stocks advancing then declining and negative when there is a larger number of declining stocks compared to advancing stocks.

The AD line rises when Net Advances becomes positive and falls when Net Advances becomes negative. The final daily NYSE advance and decline numbers are reported by the NYSE on a daily basis after the closing bell.

How To Use AD Line For Market Analysis

One way professional traders utilize the AD Line is to compare it to the stock market index and determine if the AD Line is confirming the price action of the index.

Often times, there is divergence between the AD Line and the Index which is a good indication that a short term correction is approaching.

Notice how the NYSE is beginning to decline while the AD Line is still continuing to move upwards at a slight angle. The stock market continues moving higher after the bullish divergence occurs.

The Stock Market Began Moving Lower While The AD Line Remained Bullish

Here is an example of bearish divergence between the NYSE and the AD Line. You can see how the NYSE is moving lower while the AD Line begins making higher lows.

The stock market turns bullish a short time later and continues moving higher as well.

Examining prior divergence levels between the stock market and the Ad Line suggests that most divergence occurs within a short to medium term time period.

Back testing results suggest that most periods last between 1 and 6 weeks.

Bearish Divergence Generally Occurs After Strong Down Trend

Why Is the AD Line Effective In Stock Market Trend Analysis

The AD line represents the entire stock market equally as opposed to the index which is capitalized weighted, meaning the large cap stocks influence the index substantially more than the smaller capitalized stocks.

Because the index is so easily influenced by a few large cap stocks the AD Line creates a good check and balance system to see how the stock market is behaving a a whole.

Avoid Using the Nasdaq AD Line

While the NYSE AD Line is a great indicator for stock market trend analysis, the NASDAQ AD line should be avoided for several reasons.

First, the Nasdaq exchange has a wide range of stocks including those that have been recently listed and are extremely speculative.

These issues are can move very quickly from high prices to low prices based on pure speculation.

Companies are also removed from the Nasdaq index often times due to not meeting capitalization requirements.

Because there are substantially more newer companies on the Nasdaq exchange their influence on the stock market may be short lived and less meaningful than stocks that traded on the NYSE exchange.

I highly recommend only using the NYSE AD Line in your daily stock market analysis because it is very stable and reliable on a long term basis.

Things To Keep In Mind

The AD Line is a market breadth indicator that measures broad based market participation. If the stock market rally is broad across many different sectors the AD Line will move sharply higher.

If the rally is caused by a few large capitalized stocks the AD Line will move slightly higher.

Conversely, if a stock market drop results from several hundred stocks the AD Line will drop strongly and if the decline is limited to a few large cap stocks the decline will be small.

Similarly, the AD Line does a great job of measuring divergence between the stock market.

If a bullish divergence occurs between the AD Line and the Index the stock market will most likely continue moving higher.

If a bearish divergence occurs between the stock market and the AD Line the stock market will most like begin losing steam and will experience a correction in the coming days.

Wishing you the best
By Roger Scott
Senior Trainer
Market Geeks

Trend Analysis

What is Trend Analysis?

Trend analysis is a technique used in technical analysis that attempts to predict the future stock price movements based on recently observed trend data. Trend analysis is based on the idea that what has happened in the past gives traders an idea of what will happen in the future. There are three main types of trends: short-, intermediate- and long-term.

Trend Analysis

Key Takeaways

  • Trend analysis tries to predict a trend, such as a bull market run, and ride that trend until data suggests a trend reversal, such as a bull-to-bear market.
  • Trend analysis is based on the idea that what has happened in the past gives traders an idea of what will happen in the future.
  • Trend analysis focuses on three typical time horizons: short-; intermediate-; and long-term.

What Does Trend Analysis Tell You?

Trend analysis tries to predict a trend, such as a bull market run, and ride that trend until data suggests a trend reversal, such as a bull-to-bear market. Trend analysis is helpful because moving with trends, and not against them, will lead to profit for an investor.

A trend is the general direction the market is taking during a specified period of time. Trends can be both upward and downward, relating to bullish and bearish markets, respectively. While there is no specified minimum amount of time required for a direction to be considered a trend, the longer the direction is maintained, the more notable the trend.

Trend analysis is the process of trying to look at current trends in order to predict future ones and is considered a form of comparative analysis. This can include attempting to determine whether a current market trend, such as gains in a particular market sector, is likely to continue, as well as whether a trend in one market area could result in a trend in another. Though an analysis may involve a large amount of data, there is no guarantee that the results will be correct.

Examples Of Trend Analysis

In order to begin analyzing applicable data, it is necessary to first determine which market segment will be analyzed. An example of sectors can include a focus on a particular industry, such as the automotive or pharmaceuticals sector, as well as a particular type of investment, such as the bond market. Once the sector has been selected, it is possible to examine the general performance of the sector. This can include how the sector was affected by internal and external forces. For example, changes in a similar industry or the creation of a new governmental regulation would qualify as forces impacting the market. Analysts then take this data and attempt to predict the direction the market will take moving forward.

Trend Following

Trend following is a trading system based on using trend analysis and following the recommendation produced to determine which investments to make. Often, the analysis is conducted via computer analysis and modeling of relevant data and is tied to market momentum.

Trend Trading Strategies

Trend traders attempt to isolate and extract profit from trends. There are many different trend trading strategies using a variety of indicators:

  • Moving Averages: These strategies involve entering into long positions when a short-term moving average crosses over above a long-term moving average, and entering short positions when a short-term moving average crosses below a long-term moving average.
  • Momentum Indicators: These strategies involve entering into long positions when a security is trending with strong momentum and exiting long positions when a security loses momentum. Often times, the relative strength index (RSI) is used in these strategies.
  • Trendlines & Chart Patterns: These strategies involve entering long positions when a security is trending higher and placing a stop-loss below key trendline support levels. If the stock starts to reverse, the position is exited for a profit.

Indicators can simplify price information, as well as provide trend trade signals or warn of reversals. Indicators can be used on all time frames, and have variables that can be adjusted to suit each trader’s specific preferences. Combine indicator strategies, or come up with your own guidelines, so entry and exit criteria are clearly established for trades. Each indicator can be used in more ways than outlined. If you like an indicator, research it further, and most importantly, test it out before using it to make live trades.

Limitations Of Trend Analysis

Critics of trend analysis, and technical trading in general, argue that markets are efficient, and so they already price in all available information. That means that history does not necessarily need to repeat itself, and that the past does not predict the future. Adherents of fundamental analysis, for example, analyze the financial condition of companies using financial statements and economic models to predict future price. For these types of investors, day-to-day stock movements follow a random walk that cannot be interpreted as patterns or trends.

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