Assessing trend strength
It’s usually possible to easily spot the direction of a trend by looking at a chart – that’s the easy part of trading. What’s not as easy is to work out how strong the trend is. By ‘strong’ I mean, if you’re putting your money on the trend going in the preferred direction, you would wish to have some idea of how powerful or reliable is the push. See below a clear trend down on AUDJPY. Ignore the set of indicators in the chart. The trend is what matters most.
There are several methods out there for estimating trend strength. Always keep in mind that all indicators can only rely on historical data – as no indicator can see the future. Also, trading is not simply about indicators. In this post I focus on two indicators: Aroon and the ADX (aka Directional Movement Indicator). Mind you, this is not a a tutorial. So, readers should do their own background research starting with any links in this post and using Google.
This is a time-momentum indicator. It tells something about price-momentum but focuses more on time in the markets. Strikingly the Aroon can get traders into advantageous positons where RSIs are at high or low levels (>70 or <30). Price-momentum traders generally over-estimate probabilities when relying on RSI alone. The Aroon can say that even if RSI is low or high, the ruling party (bulls or bears) may have probabilistically more time in the market, heading in the trend direction.
This is similar to the Aroon but is based more on price-momentum. Both the Aroon and the ADX tend to separate bull and bear ‘sentiment’.
Exponential Moving Averages:
I use the EMA50 and EMA100 together. This is not prescriptive to anyone. I use these because I find them most reliable for my style of trading. If I see a sharp and consistent separation of the EMA50 and EMA100 I know something is on. If the two show increasing separation from each other this tells me that the trend is strengthening.
There should be no questions such as, “Which is of the above is the best?” A tool is as good as the person operating it and it depends on the particular circumstances.
Besides indicators, I’ve also used candles themselves to give an indication. If I see a succession of very large candles in one direction at a steep angle of ‘attack’, that tells me that a strong trend is on. Whether it lasts is another matter. Of course, it’s not just about using candle size. Other indicators may come in to help. I use a variety of ‘tools’ at the same time. A good surgeon just operate using only a scalpel only. Right?
At the end of the day, the human eye (brain) is the simplest tool of all. You just look at the chart, draw a line through the trend and measure the angle of attack!
The information provided herein is opinion only. Under no circumstances do any statements here represent a recommendation to buy or sell securities or make any kind of investment. You are responsible for your own due diligence. To summarise, we do not provide investment advice, nor do we make any claims or promises that any information here will lead to a profit, loss, or any other result. All materials are for educational purposes only. We are clear in our SYP.
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