Determining the main trend direction is essential to many trading strategies’ success. Having a solid system that can help you to quickly diagnose the main trend direction is an invaluable asset. Here is a system that can do exactly that for you.
Why to use technical indicators to evaluate trend
When most traders start trading binary options, they evaluate the current market trend visually. While this is a reasonable approach at first, it has two distinct disadvantages:
1. Your trading becomes subjective
To become a successful trader, you constantly need to evaluate your trading. You need to eliminate the parts that cost you money and focus on the parts that make you money. As long as you are evaluating a trend visually, you can hardly objectively determine what you are doing right and what you are doing wrong.
You need to use a certain set of indicators to evaluate the trend. Then, you can keep the indicators that help you make good investments and replace or eliminate the indicators that cause you to get into bad investments.
2. It takes too much time
As a more advanced trader, you will be trading more and more assets. Often, traders are monitoring as much as twenty assets or even more at the same time. In that situation, evaluating each asset’s trend individually becomes a time consuming and mind-numbing task. As a trader, you need to be able to immediately know whether an asset is trending, and which direction it is trending in.
How to determine the main trend direction using technical indicators
To know whether an asset is in a trend or not and which direction the trend is moving to, you need a two-step process:
1) Evaluate the overall market direction
First of all, you need to know whether the market is currently moving up or down. That is the easy part of the job. To know which direction the market is moving in, you simply need to use a high-period moving average. High-period moving averages resemble the market’s direction most of the time.
The more periods you use to calculate your moving average, the higher the chance your moving average will move in the same direction as the market during a long movement. The high number of periods makes the moving average immune to smaller swings, and helps keep the moving average on the right track during a correction.
On the downside, the high number of periods will also make the moving average slow to react when the trend is over and the market started moving in the opposite direction. Therefore, a trader should adapt the number of periods he uses to calculate the moving average to the market environment. In an erratic, fast paced market environment, you should use fewer periods, or your moving average will react too late to catch the current trend.
In a slower market environment, however, you should use more periods to make sure small swings against the main trend direction do not distract your moving average from the main trend.
One of the most important factors on how many periods you should use is the time frame of your chart. On short time frames, market movements are more erratic. Therefore, you should use less periods for your moving average than on longer time frames.
2. Determine whether the market is trending
Moving averages are a great tool to determine the main market direction when the market is trending. Often, however, the market is not trending. In that case, a moving average will become almost useless to determine the market direction. It will start moving up and down randomly and generate a lot of false readings.
Therefore, you need to be able to determine whether the market is currently trending or not. The simplest way to do that is by using more than one moving average.
The fewer periods you use for a moving average, the closer the moving average will be to the market price at any given time. In an uptrend, the market is constantly moving up. The fewer periods you use for a moving average, the higher it will be. You can use this simple relation to your advantage to determine whether the market is trending.
Should you be using a 50 period moving average as your high-period moving average to determine the main trend direction, for example, you could use moving averages with 10 and 20 moving averages.
In an uptrend, the two low period moving averages should be closer to the market price. Therefore, they will all be to the upper side of the high-period moving average. Should the shorter moving averages all be to the lower side of the high-period moving average, the market is currently trending down. Are the short moving averages to different sides of the long moving average, however, you know that market cannot be trending right now.
Of course, you can use more than three moving averages for this technique. Just make sure that the shorter moving averages use significantly less periods than the high-period moving averages. Otherwise, the advantage of using more than one moving average will be minimal.