How A Trend Direction Indicator Can Help You Lose Money Fast
I know I may take some heat for going after the trend direction indicator as a useful technical analysis tool but the fact is that they can do more harm than good for most traders.
Indicators get a bad rap and the reason is not so much in the indicator themselves…but in how traders use them.
Trend Direction Indicators Have You Miss The Big Picture
Because most traders get handcuffed by the indicator and fail to see what price is really doing. Before I go on, I know some people are never going to give them up so here is a trend indicator for mt4 that you can download and use for free. Just apply it to your weekly or 4 hour MT4 charts if you are day trading according to the installation video and you will see how it works.
It’s no shock to learn that since indicators are a derivative of price (or volume) they are going to be lagging behind the movement of price. Depending on your settings, especially the look-back period, you may be a little behind the turn if using a short period or be miles behind. Also keep in mind that Forex does not trade through an exchange so getting a valid volume number is impossible.
If you are only keeping your eyes on the indicator, you are missing the story that price is telling you. Price will clue you in to a change in direction long before any trend indicator will.
Forex Technical Analysis Tools That Most Traders Use For Trend
No doubt one of the most popular tool used today is the moving average not only to identify zones where a short term trend reversal may take place (as in trading pullbacks – but there is no magic there) but also as trend direction indicator.
What is the most popular? Usually the 50 period, the 100 sma, the 200 sma and the 20 sma. You could swap out the sma for an ema but it makes little difference.
The question I hope you are asking is “what is so special about those numbers”?
There is nothing special except the bigger ones will be further away from current price which will lag the turns much more.
Of course there are others including CCI, MACD, Stochs and other trading indicators so out of all them, is one of them ranked as the best trend indicator? Since they all depend on some mathematical calculation of the same initial input (price) there is not one that is better than the others.
They all have the same drawback…they lag the actual price movement!
Can Candlestick Patterns Be A Trend Indicator?
There is some school of thought that an individual candlestick can help define the current trend or trend reversal. I am going to generalize here but it depends on where they form on the chart and what pattern candlestick we are looking at.
Where I take notice are candlesticks that are out of the ordinary from recent price action. For example, if this bearish engulfing candlestick takes place at a prominent resistance zone, could that suggest long before an indicator does, that a new trend direction is occurring?
It certainly can be considered a trend reversal candlestick pattern due to location (even though it’s only 2 candles) and it can range from a short term trend move to putting in a top in whatever currency pair you are looking at.
While a moving average or any other indicator is still indicating long trades, I’d be looking for a position short. You can bet that if there was a support zone close by, traders that look at lagging price indicators may look to take a long on a pattern like a pin bar or inside bar.
And that is how a trend indicator can help drain your trading account if you only focus on the indicator. It can draw your eyes away from what is really important.
Moving Average Indicator Sets You Up On Wrong Side Of Price
This may not be the best example but it gets the point home of using price and context.
You can see that price was telling a story long before that short trade set up. The bear candle after entry would have late traders jumping into what they deemed to be a move down. You can see momentum in that candles as it closed on the low of the session so you KNOW traders looked to short in the “trend direction” of short.
And they lost.
Moving average are not all bad though. Simply due to their calculations, you can see when a market is actually trending or consolidating. Make no mistake…there is no magic in those pullback trades after the upside turn. If you think about how the calculations work, you can fully understand why it can not only show a turn but also meet price at points on the chart.
- Price turns from negative to positive and turns the indicator.
- Price pushes to the upside giving a higher average price so indicator rises.
- Price pulls back at times with momentum and then consolidates.
- Moving average calculates a lower average…..meets price.
You can use a moving average as a quick scan however to see if you are looking at a chart that is moving or one that is consolidating.
Use Price Action and Patterns as Your Trend Direction Indicator
Price always tells a story and sometimes the story can be a little confusing. If it is, pick another chart. Indicators can smooth out the volatile price movements so you think you are looking at a calm chart but the reality is it’s a chart with no clear direction full of spikes back and forth.
Trading that environment will wipe you out.
Seeing momentum candles in one direction along with weaker candles in the opposite direction can be a great indicator of the current trend of price. We also can never forget the standard higher high and higher low for an uptrend and lower highs and lows for a downtrend either.
My general rule is that, as you can see on this chart with the red circle, we must see a true swing and that’s something you have to decide. Regardless, due to the strong up trend that happened after the higher low, the area with the white box, if broken, would signal to me a true trend change.
You want to help save your account? Learn some price acting trading strategies (which are really great for swing trading) from my free course and learn to listen to what the chart is telling you.
The below chart is an example of a recent trend trade I did using a 5 day EMA/ 20 day EMA crossover entry and a rising trailing stop to maximize profits. I entered $AGQ at $23.25 at the end of the day on 12/6/18 based on the 5-day / 20-day EMA crossover. My initial profit target was the 70 RSI and the 200-day SMA.2. I set the 5-day ema/ 20-day EMA cross under as the initial stop loss signal on entry.3. I set the close below the 20-day EMA as the initial trailing stop loss signal as it started to be profitable4. When the trend got under way, I moved my trailing stop loss to the 5-day EMA.5. As price accelerated even beyond the 5-day EMA I moved the trailing stop loss to a close under the previous day’s price low.6. As $AGQ broke the 200-day SMA and the 70 RSI I moved my trailing stop to a close back under the 200-day SMA or the 70 RSI, I would lock in profits based on either of those closes.7. I exited $AGQ at $27.03 for a +16.26% gain on capital at risk as price looked like it was not going to close over the 200-day SMA on 1/4/2019. This was an example of a winning trade
Trading systems based on fast moving averages are quite easy to follow. Let's take a look at this simple system. Currency pairs: ANYTime frame chart: 1 hour or 15 minute chart.Indicators: 10 EMA, 25 EMA, 50 EMA. Entry rules: When 10 EMA goes through 25 EMA and continues through 50 EMA, BUY/SELL in the direction of 10 EMA once it clearly makes it through 50 EMA. (Just wait for the current price bar to close on the opposite site of 50 EMA. This waiting helps to avoid false signals). Exit rules: option1: exit when 10 EMA crosses 25 EMA again.option2: exit when 10 EMA returns and touches 50 EMA (again it is suggested to wait until the current price bar after so called “touch” has been closed on the opposite side of 50 EMA). Advantages: it is easy to use, and it gives very good results when the market is trending, during big price break-outs and big price moves. Disadvantages: Fast moving average indicator is a follow-up indicator or it is also called a lagging indicator, which means it does not predict future market directions, but rather reflects current situation on the market. This characteristic makes it vulnerable: firstly, because it can change its signals any time, secondly – because need to watch it all the time; and finally, when market trades sideways (no trend) with very little fluctuation in price it can give many false signals, so it is not suggested to use it during such periods.
If someone was ready to start trading and had a basic understanding of the markets and asked me for some of my best advice on how they could make money as a trader, this is what I would tell them. 1.Understand that trading is like any other professional endeavor, you will be monetarily rewarded based on the effort and work you put into it to learn how to trade. Trading is one of the few fields where amateurs can go compete with professionals with a very low price of entry. Your trading tuition will have to be paid through the experience of losses and time doing your homework. You will get out of trading the effort you put into it. 2.If you have to get others opinions about your trade, asking others advice on entries and exits, then you really need to stop trading and work on a detailed trading plan that gives you a road map of how manage a trade. If you don’t have a trading plan every thing you do is random. There is no edge in randomness. 3.Do not waste your time on searching for the Holy Grail of trading, an easy money, can’t lose, trading method does not exist because markets change in cycles. Trading is always a competitive event between traders and market conditions are always changing from volatile to stable and from trending to choppy, so nothing works in all market environments. 4.Successful trading is based on your winning trades collectively being bigger than your losing trades are collectively. So your goal is to either trade a system with a few huge wins and a lot of very small losses or a high winning percentage system that keeps the losing trades controlled. 5.Do not look for a good trade, instead look for a great winning methodology to trade with. Have the right trading process and the money will follow eventually. Looking for easy money in the markets is the process for losing money. 6.Your risk management while trading will determine your trading success more than your method. You have to make it safe to be wrong a few times in a row and not lose all your trading capital. 7.If you want to be a successful trader then focus on what is actually happening with price action and stay away from your own opinions and biases of what should happen. Wanting to be right for the sake of your ego is another expensive game. You can’t predict a nonexistent future. 8.You can’t use anyone else’s system, you have to trade a system that fits you. One that you understand and can trade with discipline because of your confidence in it and yourself. 9.Look for and find your own edge. What are you the best at doing in the markets? Some are masters of shorting, others trend following, some are great at selling options that expire worthless. Usually the type of trading you are the most passionate about gives you the drive to research it until you find that edge. 10.Master some aspect of trading, find something to be an expert on. A market, a stock, IPOs, options, futures, day trading, trend following, etc. Don’t be a jack of all trades, be a master of one type of trading.