3 Technical Indicators for Trend Analysis

August 28, 2023 Beginner
Trend indicators can help traders spot potential market direction. Here's how to use three technical indicators: moving averages, MACD, and Parabolic SAR.

Some traders, especially those using technical analysis in their trading, might focus on trends. And for good reason: Prices can change quickly, and some traders like to closely monitor trends and price changes. Trend identification can be a useful tool in finding entry and exit points.

Trends occur across all different time frames, and some traders believe the earlier a trend is spotted, the better the potential opportunity they have to capitalize on it. That's easier said than done. The nice thing is there are many indicators traders can use to identify possible trends, such as linear regression, price envelopes, ADX, and Keltner channels. Three trend indicators we'll discuss here include moving averages, moving average convergence divergence (MACD), and Parabolic SAR.

1. Moving averages

There are different types of moving averages. Two common types are the simple moving average (SMA) and exponential moving average (EMA).

An SMA is calculated by totaling the closing price of a security over a set period and then dividing that total by the number of time periods.

For example, the calculation for a 10-period SMA would be:

  • CP = Closing price
  • Number = Period
  • SMA = (CP1 + CP2 + CP3 + CP4 + CP5 + CP6 + CP7 + CP8 +CP9 + CP10) / 10

The periods used for the calculation could be anything from minutes to years.

The SMA gives equal weighting to each time period, which may make it potentially well suited for identifying longer-term trends. If the security is above the moving average and the moving average has been going up, it's could be an indication of an uptrend. If the stock is trading below an uptrending moving average, it may still be an uptrend, but it might potentially be weakening. A downtrend occurs when the price is below the moving average and the moving average is pointing down.

To add SMA indicators to the thinkorswim® platform, select the Charts tab and bring up a chart. Select Studies > Add study > Moving Averages. You'll see a pretty extensive list of different types of moving averages. Select SimpleMovingAvg to plot the SMA on the chart. The default is the nine-period SMA. To change it, right-click the indicator line and select Edit study SimpleMovingAvg (CLOSE, 9, 0, no). From here, change the length to 50 and select OK. This will plot the 50-period SMA on the chart (see below).

Simple moving average

The chart illustrates the 50-day SMA for the S&P 500® index (SPX).

Source: thinkorswim platform

For illustrative purposes only. Past performance does not guarantee future results.

Another choice under the Moving Averages studies is the EMA, listed as MovAvgExponential. The EMA differs from the SMA in that its calculation assigns more weight to recent prices, making it potentially more responsive to short-term price action. As a result, the EMA tends to be used more than the SMA by short-term traders.

Exponential moving average

This intraday chart of the SPX illustrates a 10-minute EMA with a blue line. Because the more recent prices have a higher weighting, the EMA usually adjusts to price action quicker than an SMA.

Source: thinkorswim platform

For illustrative purposes only. Past performance does not guarantee future results.

The type of moving average and time periods a trader might choose depends on their preferred trading style and time horizon. Traders could experiment with different indicators and strategies to determine what works best for their trade objectives.

2. Moving average convergence divergence (MACD)

The moving average convergence divergence indicator, or MACD, combines both trend identification and timing into one tool. The MACD belongs to a group of technical indicators called oscillators because they tend to move back and forth from one side to the other over a period of time.

The MACD is built on the idea that when moving averages begin to diverge from each other, momentum is generally thought to be increasing and a trend may potentially be starting. The creator of the MACD, Gerald Appel, recommends using the settings of 8 and 17 periods to enter a position on a daily chart but suggests a different combination (12 and 26 periods) for selling opportunities. The 9-period MACD average would apply to both. Of course, keeping Appel’s original intent in mind, the individual trader would need to decide how to use the MACD.

When the indicator line crosses above that signal line, it means an upward trend may be starting, and when it crosses below, it may signal the start of a downtrend. The MACD can also be plotted as a histogram. When bars are above the zero line, it indicates a potential upward trend, and when the bars are below the zero line, it could mean a downtrend. The two-line and histogram MACD is plotted in the subchart below the price chart. To add the MACD indicator to a chart, under the Charts tab in thinkorswim, select Studies> Add study> Momentum Studies> A-M> MACD.

 

Applying the MACD

Chart illustrates the MACD indicator plotted on a subchart below the stock chart as two lines and a histogram.

Source: thinkorswim platform

For illustrative purposes only. Past performance does not guarantee future results.

The 12-26-9 configuration is the default setting on thinkorswim, but it's possible to adjust the inputs depending on your trading preferences. Right-click the MACD indicator line, then select Edit study MACD. In the MACD Customizing window, change the input parameters and then select Apply.

3. Parabolic SAR

Another potential thinkorswim indicator for a trend-finding arsenal is the Parabolic "stop and reverse" (SAR).

The Parabolic SAR indicator is designed so that when a security is in an uptrend, the indicator is plotted below the price in the form of a dot (see below). This dot is the theoretical "stop" in the stop and reverse, the point at which (if the price touches it) the trend may have changed. When this happens, the Parabolic SAR is automatically plotted above the price, indicating a downtrend is in effect. Some traders use the Parabolic SAR to help determine where to place stop orders.

To add the Parabolic SAR to a chart, under the Charts tab in thinkorswim, select Studies> Add study> Upper Studies> M-P> ParabolicSAR.

Using Parabolic SAR to identify trends

Chart illustrates Parabolic SAR plotted as a yellow dot above or below the daily close, indicating potential trend direction. When the price moves below or above these dots, it could indicate a trend direction change.

Source: thinkorswim platform

For illustrative purposes only. Past performance does not guarantee future results.

As you can see from the chart above, the longer the Parabolic SAR is below (or above) the prevailing price, the stronger the trend may be. However, on short-term time frames, the Parabolic SAR may be more susceptible to false signals (what some traders call "whipsaws"). Like all trend-following thinkorswim indicators, the inputs for Parabolic SAR can be customized and used with any time frame.

Beyond these three technical trend analysis indicators, there are many other ways to identify and analyze trends in trading and investing. These studies can be used as stand-alone indicators or in conjunction with other indicators. Each trader should study these indicators to determine what will best serve their trading strategy.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

0723-3YS0