Trading with trends in the market can not only add accuracy to a trading strategy but can also add to the risk-reward ratio of that same strategy, overall increasing the profit potential of any strategy you use.
These are the top three ways how to actually identify a trend.
1. Using Two Different Moving Averages
This is the most simple way to identify a trend and by far the most non-subjective. And what I mean by that is that it’s very easy to identify when it comes to this way of identifying a trend. So for me, the two that worked best in my own personal trading was the 200-day moving average and the 100-day moving average. As you can see on the picture, the red line being the 200-day and the blue line being the 100-day moving average.
Now, with this being the case, the reason this is so non-subjective and frankly hard to mess up is that all you’re looking for is your 100 day moving average to be below or above your 200-day moving average in order to identify this market as in an up or a downtrend.
A lot of people, whenever they consider moving averages in trading, think about crossover strategies and actually placing trades based around a moving average. That is not a very good way to trade because of how these indicators lag.
Moving averages are going to be a lagging indicator and these are going to be lagging even when it comes to identifying a trend. But when it comes to the easy, non-subjective way to look at the market and identified as either in an uptrend or a downtrend, these moving averages can work really well, especially for beginner traders that have trouble identifying market trends using only market structure.
You can see an example of a crossover on this picture.
This is a moving average crossover and I’m not talking about trading when the market crosses over. That’s not a very intelligent entry reason. But what I’m talking about is waiting on that cross of those moving averages to identify the market afterward as downtrend as soon as this cross happens.
What you can do is say after the cross, if my 100-day moving average, the blue line is below my 200-day moving average 100 below the 200, then I only look for short trade to using my specific entry reason.
But that’s how you would use this specific way of identifying a trend in order to trade in the markets. And as simple as this sounds, it would add a ridiculous amount of accuracy to most of your trades.
And it’s not even the fact that you have a difficult time identifying trends, using structure, maybe you just see it as a little bit too subjective and you can’t come up with the perfect set of rules in order to do that.
If you can if you look at a chart and you can’t automatically tell what trend it’s in, then you probably need to try to find a new way to identify a trend for now until you get a little better at identifying mark market structure and identifying market trends.
And it really doesn’t matter what the moving averages are when it comes to the numbers, you can use a 50 and 100, you can use a 20 and a 50. As long as one is smaller than the other one, this will work.
The 100-day and the 200-day exponential moving average is what I chose to use in this scenario as you can see on this picture. Where the first crossover is, you can see that while the blue line is above our red line, what we’re looking for is long trades, looking for the market to continue that trend in the upper direction. And on the spot where the second crossover is and while the blue line is below our red line, we’re looking for short trades and a continuation of a downtrend.
So that’s our first and most simple way of identifying the trend that I’ve used in my own personal trading.
2. Using One Moving Average
Now we’re going to take a look at a different way of identifying trend still using a moving average. But instead of having two moving averages, what we’re gonna do is just take off the 100-day moving average. And this is going to be the second most simple way to identify market trends.
And in this case, instead of waiting on the moving average crawls, as you can see on the picture, that moving average cross happened right there where it’s marked. So this way of identifying a trend, although a bit more complicated and subjective than using a moving average cross to identify a trend, will give you a faster trend identification. As you can tell, the market breaks below the 200-day moving average and this is where our downtrend started when using the moving average cross.
So it gives you a little bit of a faster signal, but it can also be a bit more subjective because you don’t want to be trading trend continuation while the market is consolidating. And in this area, as you can see in the picture, these consolidation areas can be extremely tricky to find when using just one moving average in order to identify a trend.
The moving average that I used when only using one moving average has varied between the 20 one hundred and 200-day moving averages. For this example, we’re going to use the 200. What I would do is just test strategies with each of those. Being your trend ID if you’d like to use this non-subjective way of identifying the trend and see which one works best for you.
So using just one moving average to identify trends is an extremely simple process. All you should be doing is looking for price action above the moving average or below the moving average. And when the moving average is going sideways like on the picture.
Choose not to trade. When price action is touching and bouncing off of the moving average multiple times, that’s when you should stay out of the market when using this way of identifying a trend. Stay out of the market at least for trend continuation trades and for counter-trend trades such as advance patterns and other things.
This type of market right in here works really well. But today we’re talking about trade continuation trade. So in that case, what I’d be looking for is this moving average to be moving up or down price action to be above or below it and then looking for into reasons based on that trend ID. In the case of the above, we’d be looking for only long trades. In the case of below, we’d be looking for only short trades.
3. Using Only Price Action
So now, we’re going to move on to the third way of identifying a trend, and that is going to be the most complicated to understand and learn. But for me, in my own personal trading, it has also proven to be the most profitable, that is using only price action.
And as I said, this can be extremely tricky. It can also be much more subjective. So it’s very important to have very specific rules when identifying trends, using only price action.
The rules that you should be using is called the break and closed below and above rule.
As you can see on the picture, what you should be looking for in this case is for a market to create a low, then a lower high, followed by a breaking close below that previous low. And in order for the trend to be a continuation of the trend, you should continue to look for the same thing over and over.
So, yes, you can see on this picture that we would still be considered in a downtrend because we’ve had this low be broken and closed below after a lower high. Then we had this low that was broken and closed below after lower high. What we’re expecting now is a continuation of that trend, a lower high, followed by breaking close below this previous low.
And this is the way you would identify a trend using only price action, using only structure. This definitely gives the fastest signals of a possible reversal, gives the fastest signals of trend continuation, and is proving to be one of the more profitable ways for me to identify a trend in my own personal trading.