Trend Trading: The 4 Most Common Indicators
Trend traders attempt to isolate and extract profit from trends. There are multiple ways to do this. Of course, no single indicator will punch your ticket to market riches, as trading involves factors such as risk management and trading psychology as well. But certain indicators have stood the test of time and remain popular among trend traders.
In this article, we provide general guidelines and prospective strategies for each of the four common indicators. Use these or tweak them to create your own personal strategy. (For more, see: Trading Volatile Stocks With Technical Indicators.)
[Trend trading makes extensive use of technical analysis, including both chart patterns and technical indicators. If you are new to technical analysis or want to brush up on your skills, the Technical Analysis course on the Investopedia Academy provides an in-depth overview of the technical concepts you need to become a successful trend trader.]
Moving averages "smooth" price data by creating a single flowing line. The line represents the average price over a period of time. Which moving average the trader decides to use is determined by the time frame in which he or she trades. For investors and long-term trend followers, the 200-day, 100-day and 50-day simple moving average are popular choices.
There are several ways to utilize the moving average. The first is to look at the angle of the moving average. If it is mostly moving horizontally for an extended amount of time, then the price isn't trending, it is ranging. If the moving average line is angled up, an uptrend is underway. Moving averages don't predict though; they simply show what the price is doing, on average, over a period of time.
Crossovers are another way to utilize moving averages. By plotting a 200-day and 50-day moving average on your chart, a buy signal occurs when the 50-day crosses above the 200-day. A sell signal occurs when the 50-day drops below the 200-day. The time frames can be altered to suit your individual trading time frame.
When the price crosses above a moving average, it can also be used as a buy signal, and when the price crosses below a moving average, it can be used as a sell signal. Since price is more volatile than the moving average, this method is prone to more false signals, as the chart above shows.
Moving averages can also provide support or resistance to the price. The chart below shows a 100-day moving average acting as support (i.e., price bounces off of it).
[Want to learn more about common trends in trading? Enroll in Investopedia Academy's Trading for Beginners course now.]
MACD (Moving Average Convergence Divergence)
The MACD is an oscillating indicator, fluctuating above and below zero. It is both a trend-following and momentum indicator.
One basic MACD strategy is to look at which side of zero the MACD lines are on. Above zero for a sustained period of time, and the trend is likely up; below zero for a sustained period of time, and the trend is likely down. Potential buy signals occur when the MACD moves above zero, and potential sell signals when it crosses below zero.
Signal line crossovers provide additional buy and sell signals. A MACD has two lines – a fast line and a slow line. A buy signal occurs when the fast line crosses through and above the slow line. A sell signal occurs when the fast line crosses through and below the slow line. (For more, see: MACD: A Primer.)
RSI (Relative Strength Index)
The RSI is another oscillator, but because its movement is contained between zero and 100, it provides some different information than the MACD.
One way to interpret the RSI is by viewing the price as "overbought" – and due for a correction – when the indicator is above 70, and viewing the price as oversold – and due for a bounce – when the indicator is below 30. In a strong uptrend, the price will often reach 70 and beyond for sustained periods, and downtrends can stay at 30 or below for a long time. While general overbought and oversold levels can be accurate occasionally, they may not provide the most timely signals for trend traders.
An alternative is to buy near oversold conditions when the trend is up, and place a short trade near an overbought condition in a downtrend.
Say the long-term trend of a stock is up. A buy signal occurs when the RSI moves below 50 and then back above it. Essentially, this means a pullback in price has occurred, and the trader is buying once the pullback appears to have ended (according to the RSI) and the trend is resuming. The 50 level is used because the RSI doesn't typically reach 30 in an uptrend unless a potential reversal is underway. A short-trade signal occurs when the trend is down and the RSI moves above 50 and then back below it.
Trendlines or a moving average can help establish the trend direction and in which direction to take trade signals. (See also: Momentum and the Relative Strength Index.)
On-Balance Volume (OBV)
Volume itself is a valuable indicator, and OBV takes a lot of volume information and compiles it into a single one-line indicator. The indicator measures cumulative buying/selling pressure by adding the volume on up days and subtracting volume on down days.
Ideally, volume should confirm trends. A rising price should be accompanied by a rising OBV; a falling price should be accompanied by a falling OBV.
The figure below shows shares of Netflix Inc. (NFLX) trending higher along with OBV. Since OBV didn't drop below its trendline, it was a good indication that the price was likely to continue trending higher after the pullbacks.
If OBV is rising and price isn't, price is likely to follow the OBV and start rising. If price is rising and OBV is flat-lining or falling, the price may be near a top. If the price is falling and OBV is flat-lining or rising, the price could be nearing a bottom. (For more, see: Uncover Market Sentiment With On-Balance Volume.)
The Bottom Line
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. (For additional reading, check out: Keep It Simple and Trade With the Trend.)
Best 5 Forex Candlestick Patterns for Day Trading
Forex candlestick patterns are crucial for the success of your price action technical analysis. Along with chart patterns, traders constantly use candlestick patterns for day trading to open and close different trades. This is so because every Forex candle pattern contains a tradable potential. For this reason, I will dedicate the following material to the best 5 candle patterns Forex indicators and the way they should be traded when spotted on the chart.
What are the Forex Candlestick Patterns?
Forex candlestick patterns are special on-chart formations created by one or few Japanese candlesticks. There are many different candlestick pattern indicators known in Forex, and each of them has specific meaning and tradable potential.
Forex traders constantly use candlestick chart patterns for day trading to foretell potential price moves on the chart. Forex candlesticks help them guess where the price will go and they buy or sell currency pairs based on what the pattern is telling them. Therefore, you should also spare time to examine the best candlestick patterns for intraday trading if you want to be a successful Forex trader.
Type of Candlestick Patterns for Day Trading
There are two types of Forex candlestick patterns for day trading – continuation and reversal candle patterns. Let’s now briefly go through each of these two kinds.
Continuation Forex Candle Patterns
Continuation Forex candle patterns are the ones that come after a price move and have the potential to continue the price action in the same direction.
The truth is that continuation candle patterns are not very popular in Forex trading. The reason for this is that they are not that many. In comparison to that, reversal candlestick patterns are dominating the Forex charts.
Reversal Forex Candle Patterns
The reversal Forex candle patterns are the ones that come after a price move and have the potential to reverse the price action.
Compared to continuation candle patterns, the reversal candle pattern indicators are the majority of the candle patterns you will meet on the Japanese candlestick charts.
Best 5 Candlestick Patterns Explained with Examples
In this relation, you should not be surprised that the best 5 candlestick patterns for day trading are reversal patterns. 5 of the most profitable Forex candlestick indicators are:
- The Doji Family
- Tweezer Tops / Tweezer Bottoms
- The Hammer Family
- Three Inside Ups / Three Inside Downs
- Evening Star / Morning Star
Notice that I have separated these into “families” or in their bullish and bearish versions since they refer to the same thing but upside down. Let’s now explain each of these with examples.
Doji Candle Patterns
The Doji candle family consists of single candle formations where the price action opens and closes at the same price. Every Doji candlestick symbolizes the equalization of the bearish and the bullish forces. This means that the current price trend is getting exhausted and it is likely to be reversed.
The Doji Forex pattern could appear after bullish moves as well as after bearish moves. Despite that, the function of the pattern stays the same – to reverse the price action.
Since the Doji candle closes at the same level where it opened, the candle looks like a dash. Yes, but this is not the only Doji candle pattern known in Forex trading. There are other Doji candlesticks too. Below you will find the most popular Doji candlestick pattern types.
The confirmation of all of the Doji patterns comes when with the finish of a candle that closes in the direction that is opposite to the trend. This candle is the first indication that the reversal is beginning.
Tweezer Tops and Tweezer Bottoms
The Tweezer Tops is a double candlestick pattern Forex indicator with reversal functions. The pattern comes at the end of bullish trends and signalizes about the beginning of a fresh bearish move.
The first candle of the Tweezer Top candlestick formation is usually the last of the previous bullish trend. The second candle of the Tweezer Top pattern should have an upper shadow that starts from the top of the previous shadow. At the same time, the upper shadows of the two candles should be approximately the same size.
The Tweezer Tops has its opposite equivalent that is called Tweezer Bottoms. The Tweezer Bottoms Forex pattern has absolutely opposite structure. The pattern comes after price drops and signalizes upcoming bullish moves.
The first candle of the Tweezer Bottom is usually the last candle of the previous bullish trend. The second candle of the Tweezer Bottom pattern should have a lower shadow that starts from the bottom of the previous shadow. At the same time, the lower shadows of the two candles should be approximately the same size.
The confirmation of the Tweezer Candlesticks comes with the candle that manages to close beyond the opposite side of the pattern. This candle is a strong indication that the trend is reversing.
The Hammer Family
The Hammer candlestick pattern is a single candle pattern that has three variations depending on the trend they take part in. Every Forex candlestick that belongs to the Hammer family has a small body and a big upper or smaller shadow. At the same time, the other shadow is either missing or very small.
You will guess right if you are wondering if the name of the Hammer candle family comes from the structure of the candles. The candles in the Hammer family are four, and they all have reversal character.
Let me meet you with these candles now:
I have shown the bullish and the bearish version of each candle. Notice that it doesn’t matter which of the two candles you will receive. The meaning is the same.
Hammer Candlestick Chart Pattern
The first candle on the sketch is the Hammer candlestick chart pattern. The candle emerges during bearish trends and signalizes that a bullish move is probably on its way. The Hammer candle has a small body, a long lower shadow and a very small or no upper shadow. Traders use the Hammer candlestick to open long trades.
Inverted Hammer Candlestick Pattern
The Inverted Hammer candle has absolutely the same functions as the Hammer candle, but it is upside down. The Inverted Hammer has a small body, a big upper shadow, and a small or no lower shadow. Same as the Hammer candle, the Inverted Hammer candlestick comes after bearish moves and signalizes that a fresh bullish move might be emerging. Traders use the Inverted Hammer pattern to open long trades.
Hanging Man Candle Pattern
The Hanging Man candlestick is absolutely the same as the Hammer candlestick pattern. It has a small body, a long lower shadow and a very small or no upper shadow. However, the Hanging Man Forex pattern occurs after bullish trends and signalizes that the trend is reversing. In this relation, the Hanging Man candle pattern is used by traders to open short trades.
Shooting Star Candlestick Pattern
The Shooting Star candle pattern has the same structure as the Inverted Hammer candle. It has a small body, a long upper shadow and a tiny or no lower shadow. However, the Shooting Star Forex candle comes after bullish trends and signalizes that the bulls are exhausted. As a result, a reversal and a fresh price decrease usually appear afterward. In this relation, Shooting Star candlestick chart pattern acts as a signal to short Forex pairs.
The confirmation of the Hammer, Inverted Hammer, the Shooting Star and the Hanging Man comes with the candle which closes in the direction opposite to the trend. This candle is likely to be the first of an eventual emerging trend.
Three Inside Up and Three Inside Down Candlestick Patterns
The Three Inside Up is another reversal candle pattern indicator that comes after bearish trends and foretells fresh bullish moves. It is a triple Forex candlestick pattern that starts with a bearish candle. The pattern continues with a bullish candle, which is fully engulfed by the fist candle, and which closes somewhere in the middle of the first candle. The pattern ends with a third candle, which is bullish and breaks the top of the first candle.
The first candle of the Three Inside Up candle pattern is usually the last candle of the previous bearish trend.
The Three Inside Up has its opposite equivalent – the Three Inside Down candlestick pattern. The Three Inside Down is a mirror image of the of the Three Inside Up. It comes after bullish trends and usually begins fresh bearish moves.
The Three Inside Down candlestick pattern starts with a bullish candle, which is usually the last of the previous bullish trend. The pattern continues with a second candle – a bearish one that is fully engulfed by the first candle and closes somewhere in the middle of the first candle. The pattern then continues with a third candle, which is bearish and goes below the beginning of the first candle.
The confirmation of the Three Inside Up and the Three Inside Down candlestick patterns comes with the third candle that closes beyond the beginning of the first candle of the pattern.
Morning Star Candle and Evening Star Candle Pattern
The Morning Star candle pattern is another three bar formation that has reversal functions. The Morning Star candlestick chart pattern comes after bullish trends and signalizes eventual price reversal.
The pattern starts with a bullish candle that is long, and it is usually the last candle of the previous bullish trend. Then it continues with a very small candle that could sometimes even be a Doji star, and it is possible that this candle sometimes gaps up. The third candle of the pattern is bearish and goes below the middle point of the first candle, and it could also gap down from the second candle.
The opposite equivalent to the Morning Star Forex figure is called Evening Star candlestick pattern. The Evening Star Forex figure is a mirror version of the Morning Star that comes after bearish trends and signalizes their reversal.
The Evening Star candle pattern starts with a bearish candle that is long, and it is usually the last candle of the previous bearish trend. Then it continues with a very small candle that could sometimes even be a Doji star, and it is possible that this candle sometimes gaps down. The third candle of the pattern is bullish and goes above the middle point of the first candle of the pattern. It could also gap up from the second candle.
The confirmation of the Morning Star and the Evening Star candlestick reversal patterns comes with the end of the third candle. If the pattern emerges meeting the requirements of the three candles then you can trade in the respective direction.
Best Forex Candlestick Patterns Cheat Sheet
I have created a simple candlestick pattern cheat sheet for your convenience. It contains all the sketches shown above.
You can use these Forex candlestick patterns for day trading by simply peeking at the cheat sheet to confirm the patterns. Save the image on your PC, or simply print it for your convenience.
Real Examples of Candle Pattern Indicators
Now that you are familiar with the structure of the best candlestick patterns for intraday trading, I suggest that we go through coupe chart examples of how these work in trading.
The first example on the chart shows the Three Inside Up and the Three Inside Down chart pattern indicators in action. See that after each of these two patterns the price action creates a turning point and the price reverses the previous trend.
You should open a short trade at the Three Inside Down pattern and a long trade at the Three Inside Up Pattern. You should place your Stop Loss orders at the opposite side of the patterns as shown in the image.
This is a Tweezer Bottoms Forex candle pattern. See that the lower shadows of the two candles start and end approximately at the same level, which confirms the validity of the pattern. As a result, the price action reverses, which triggers a long trade. At the same time, you should put a stop loss order below the lowest point of the pattern.
Now let’s go through the Morning Star candle pattern and the Hanging Man candlestick. Both patterns have the ability to end a bullish trend and to start a fresh bearish move.
You should approach both patterns with a short trade, and you should sell upon their confirmation placing Stop Loss orders above their high. As you see, in both cases the price decreases after the confirmation of the pattern.
Lastly, we will discuss a Doji candlestick pattern that comes after a bearish trend. Our Doji candlestick analysis shows that the price ends the bearish move and starts a fresh bullish move.
You should trade in bullish direction here placing a Stop Loss order below the lowest point of the Doji star candle.
Stop Loss Orders on Forex Candle Patterns
You should always use a Stop Loss order when trading Forex candle patterns. As you have probably seen on the trading images above, the best place for your stops on candle trades is at the opposite side of the patterns.
If you are trading a bullish candlestick pattern, place your Stop Loss order below the formation. If you are trading a bearish candlestick pattern, then you should place your Stop Loss order above the candle figure on the chart.
Take Profit Orders and Targets on Forex Candlesticks
The rule of thumb says that you should trade every candle pattern for a minimum price move equal to the size of the pattern measured from the tip of the upper shadow to the tip of the lower shadow.
In some cases, the price action will continue further than that. Therefore, use the basic price action rules to determine further exit points on the chart. If you spot another candle pattern during you trade that suggests the end of the trend, you should simply exit your trade and collect your profit.
- Forex candlestick patterns are crucial for the price action technical analysis of currency pairs.
- The candlestick pattern indicators form on the Japanese candlestick charts that visualize the price action of Forex pairs.
- There are two main types of candle patterns Forex indicators:
- Continuation candle patterns – not very popular in Forex trading
- Reversal candle patterns – widely used to profit on the Forex market
- The best Forex candlestick patterns for day trading have reversal character. These are:
- The Doji Candlestick Patterns – Doji, Long Legged Doji, Dragonfly Doji, Gravestone Doji, and Four Price Doji
- Tweezer Tops and Tweezer Bottoms
- The Hammer Candle Pattern Family: Hammer, Inverted Hammer, Shooting Star, and Hanging Man
- Three Inside Up and Three Inside Down
- Evening Star and Morning Star Candle Patterns
- You should place your Stop Loss orders at the opposite side of the candle pattern you are trading.
- Stay in each candle trade for a minimum price move equal to the size of the pattern. Extend your targets by applying price action rules.
GET STARTED WITH THE FOREX TRADING ACADEMY
Damyan is a fresh MSc International Management from the International University of Monaco. During his bachelor and master programs, Damyan has been working in the area of financial markets as a Market Analyst and Forex Writer. He is the author of thousands of educational and analytical articles for traders. When being in bachelor school, he represented his university in the National Forex Trading Competition for students in Bulgaria and got the first place among 500 other traders. He was awarded a cup and a certificate at an official ceremony in his university.