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The trend is your friend and this
article reviews the 7 most popular trend indicators to help you make an
extensive and in-depth assessment of whether you should be buying or selling
stocks, bonds, ETFs, gold or silver for your portfolio. If ever there was a
"cut and save" investment advisory this article is it.
It is always hard to know what to
buy or sell let alone just when to do so. Thank goodness there are indicators
available that provide such information. Below are descriptions of the 7 most
popular trend indicators: Crossovers; Moving Average Convergence Divergence;
Percentage Price Oscillator; Keltner Channels; Parabolic SAR; Traders' Index;
and Advance/Decline Line
Trend Indicators
The price movement of a security
over time is most easily analyzed by observing how its moving averages are
trending. Either a simple moving average (where the movement during a
specific time period is divided by the days of that time period) or an
exponential moving average (where a mathematical formula gives greater emphasis
to the more recent price movement) can be used and any period of time (up to
360 days on the various fine charting sites) can be studied.
The most common short-term time
period is 20- or 21-days using an exponential moving average (ema), while the
most popular medium-term periods are the 39- or 40- and 50-day using a simple
moving average (ma).
To observe the long-term trend of
the price movement of a security a 200-day ma is usually used and
occasionally a 100-day ma. That being said, a large number of variations have
been developed to satisfy particular needs and situations.
The Seven Most Popular Trend Indicators
1. Crossovers
- used to forecast the future
movements in the price of a stock such as when a stock or index moves above
(bullish) or below (bearish) its 20-day moving average.
When a security's long-term moving
average (e.g. 50-day ma or ema) moves above its short-term moving average
(e.g. 20-day ma or ema) it is referred to as a Death Cross and indicates a
bear market on the immediate horizon, especially when it is reinforced by
high trading volumes. Conversely, when a security's short-term moving average
moves above its long-term moving average, coupled with high trading volumes,
it is referred to as a Golden Cross and indicates a bull market on the
immediate horizon.
2. Moving Average
Convergence Divergence (MACD)
- a trend-following momentum
indicator of the exponential moving average (ema) of a stock or index which
is used to identify short-term momentum. Specifically, the 26-day ema of a
stock or index is subtracted from the 12-day ema to show an intermediate
trend line. A 9-day ema, the 'signal line,' is then plotted over that
intermediate term line to identify when to buy or sell the stock or index.
When the resultant MACD falls below the signal line, it is a bearish signal,
which indicates that it may be time to sell.
Conversely, when the MACD rises
above the signal line, the indicator gives a bullish signal, which suggests
that the price of the asset is likely to experience upward momentum. Many
traders wait for a confirmed cross above the signal line before buying or
selling to avoid doing so too early and thereby avoid being 'faked out'.
Traders also watch for a move
above or below the zero line because this signals the position of the
short-term average relative to the intermediate-term average. When the MACD
is above zero, the short-term average is above the intermediate-term average,
which signals upward momentum. The opposite is true when the MACD is below
zero. The zero line often acts as an area of support and resistance for the
indicator.
3. Percentage
Price Oscillator (PPO)
- similar to the MACD but while
the MACD shows the simple difference between the 2 exponential moving
averages the PPO expresses this difference as a percentage which allows a
trader to compare stocks with different prices more easily.
For example, regardless of the
stock's price, a PPO result of 10 means the short-term average is 10% above
the intermediate-term average. That makes it much easier to choose one stock
over another should the need arise.
4. Keltner
Channels
- moving average bands/channels
where the upper line represents the average high of a security over a 10-day
period; the lower band the average low of a security over a 10-day period and
the centre line the closing price of a security over the same 10-day period.
The trader is to sell the security
when the closing price exceeds the upper band and to buy the security when
the closing price falls outside the lower band. Like the other indicators
mentioned it is best to add two or three other indicators to one's charts to
confirm any buy/sell signal.
5. Parabolic SAR
- used to determine the direction
of a security's momentum and the point in time when this momentum has a higher-than-normal
probability of switching directions.
The parabolic SAR is shown as a
series of dots placed either below a security's price on a chart (a bullish
signal causing traders to expect the momentum to remain in the upward
direction) or above (a signal that the bears are in control and that the
momentum is likely to remain downward).
As the price of the security
rises, the dots will rise as well, first slowly (i.e. spaced well apart) and
then picking up speed (i.e. getting closer and closer together) and
accelerating with the trend. This accelerating system allows the investor to
watch the trend develop and establish itself. The SAR starts to move a little
faster as the trend develops and the dots soon catch up to the price line and
that is when it is time to buy the security. A sell signal is triggered when
the price line moves below the lower dot enabling an investor to position a
stop-loss order.
The ability for the parabolic SAR
to respond to changing conditions removes all human emotion and allows the
trader to be disciplined. On the other hand, while the SAR works extremely
well when a security is trending, it can lead to many false signals when the
price moves sideways or is trading in a choppy market. That being the case,
it is paramount that other indicators such as the stochastic oscillator,
moving averages, etc. be used to ensure that all information is being
considered.
6. Traders' Index
(TRIN)
- a short-term breadth indicator
which measures the ratio of advancing stocks to declining stocks and compares
it to the ratio of advancing volume to declining volume.
When advancing volume exhibits
discordance with the raw number of advancing stocks, the all-important sell
signal is given. Conversely, when volume on the downside increases out of
proportion with the number of declining stocks, an upside reversal is said to
be imminent.
It is important to note that TRIN
is handled differently in each of the different market conditions. In a bull
market, the overbought line is placed at 0.65 or 0.70 but in a bear market at
0.70 or 0.75. The oversold line is placed at 0.90 or 0.95 in a bull market
and at 1.00 or 1.10 in bear markets. Assuming the market has been correctly
identified as a bull or a bear and the overbought and oversold lines have
been correctly placed you should buy when the current TRIN crosses above its
oversold line and sell when TRIN sinks below its upper overbought line.
When interpreted properly, TRIN
can be one of the most powerful and accurate means of assessing the
psychology of the market.
7.
Advance/Decline Line (A/D)
- used to confirm the strength of
a current trend and its likelihood of reversing. If the markets are up but
the A/D line is sloping downwards, it's usually a sign that the markets are
losing their breadth and may be setting up to head in the other direction. If
the slope of the A/D line is up and the market is trending upward then the
market is said to be healthy.
Conclusion
Remember, the trend is your friend
and now you have an arsenal of such indicators to make an extensive and
in-depth assessment of whether you should be buying or selling - be it
stocks, warrants, bonds, ETFs, gold or silver.
If ever there was
a "cut and save" investment advisory this article is it.
Lorimer Wilson
MunKnee.com
Lorimer
Wilson is Editor of www.FinancialArticleSummariesToday.com (F.A.S.T.) and www.MunKnee.com (Money, Monnee, Munknee!) and an economic analyst and financial
writer. He is also a frequent contributor to this site and can be reached at
editor@munknee.com.
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