Thursday, December 23, 2010

They say the trend is your friend...

The old saying is the "the trend is your friend". Most technicians live by this saying and would advise others to always trade in the direction of the trend. But how do you define the direction of the trend to fit your trading time frame?

The first thing you can do is look at a chart and based on what you see decide if the underlying is trending up, down, or sideways. You can do this on any time frame. Sometimes it is hard to tell, so people will through moving averages on a chart to help better identify the trend. Some of the most popular are the 50 and 200 day moving averages. In technical terms if the 50 day MA is trading above the 200 day MA, the underlying is said to be in an uptrend and vice a versa. This is great if you are a longer term trader, but what can you use for the active trader who trades week to week, or month to month?

I personally know that I am a short term trader and I need a way to identify the trend this week, not this year. So I started playing with different sets of moving averages and found that for me the 5 and 10 day moving average work best for my time frame. I have found that more often then not, when the 5 day MA is trading above the 10 day MA then we are in a confirmed uptrend and when it is trading below then we are in a confirmed downtrend.

Lets look at a chart for the SPY ETF:

Of the 12 crossings I highlighted in the above chart, 10 were very clear confirmations of the short term trend. And if you were trading based off these signals they would had given you the confidence to stay in the trade much longer then you otherwise might have.

I like this set of moving averages, because you get feedback much soon then you would on a set of larger moving averages.

Do your own research and find out what works best for you!

1 comment:

  1. Wow, that's kind of powerful. The odds of 12 confirmations based on randomness using statistics are so great that you have to give some credence to this. Thanks for sharing.