The trend is an essential aspect of trading which helps traders to read the market’s directional movement better so that they can use their trading strategy at the right moment. In this article, we will explore the top 5 trend strength indicators that help traders to understand trend structure in particular.
28 May, 2020, | AtoZ Markets – Trend strength is the power the bulls or bears have over the market over a specific period. In a weak uptrend, the trend may be in the bullish, but it still faces significant downward pressure. However, in a strong uptrend, the trend is completely bullish, and the bears usually wait behind the scenes.
A strong trend can potentially give traders a low risk and high-profit trades. On the other hand, a weak trend can potentially lead to high-risk trades. Trading in a weak trend can also hamper a trader’s confidence.
Best Trend Strength Indicators for Traders
Traders can determine the trend strength through the use of volume and price data, various indicators etc. However, we have discussed the top 5 trend strength indicators below that help trader to measure the trend strength.
Average Directional Index (ADX)
ADX (Average Directional Movement Index) is one of the most popular trend strength indicators, developed by Welles Wilder. It is an average of expanding price range values. However, the trader often uses it to measure the overall trend strength. But it does not provide information about the direction. It gives the positive and negative directions of trend strength using the DMI + and DMI -.
Generally, when ADX is above 25, it suggests a strong trend. But when below 20, it suggests no trend. When the trend declines from high values, then the trend is probably ending. Staying low value for a long time, then the ADX increases to 20, it probably signals a trend. The direction of the ADX line is also essential to determine the trend strength. When the ADX line is going up, the trend strength is increasing. When the line is going up, the trend strength is decreasing.
True Strength Index (TSI)
Developed by William Blau, the True Strength Index (TSI) is a momentum oscillator. It is used to smooth price changes. It captures the ebb and flow of price action and filters out noise.
To smooth price changes, TSI uses three parts, the double smoothed price change, the double smoothed absolute price change, and the TSI formula. First, it calculates the price change in 25-period EMA. Next, it calculates the previous output price change in 13-period EMA for double smoothing. Last, it calculates the TSI value by plugging the double-smoothed price change into the TSI formula.
Generally, when TSI is above 0, it gives uptrend signals. When TSI in overbought territory, it gives downtrend signals. The TSI’s values are calculated using the following formulas:
TSI = 100 x EMAS2(EMAS1(PM)) / EMAS2(EMAS1(PM1))
- PM – is the current period’s real price momentum.
- PM1 – is the current period’s absolute value price momentum.
- EMAS1 – The number of periods is specified by the Smooth 1 Calculation parameter
- EMAS2 – The number of periods is specified by the Smooth 2 Calculation parameter
Rate of Change (ROC)
The Rate of Change (ROC) is a pure momentum oscillator. It is also a popular trend strength indicator. The indicator also shows overbought and oversold market conditions. It shows the changes by comparing the current price with the price of specific periods ago. Moreover, it changes above and below the zero line, according to the positive and negative ROC value.
In general, If ROC is above the zero line or the value is positive, it reflects a sharp price advance. Conversely, If ROC is below the zero line or the value is negative, it indicates a steep price decline. The value of ROC changes according to the change of the current price with an earlier closing price.
ROC = [(Today’s Closing Price – Closing Price n periods ago) / Closing Price n periods ago] x 100
Ichimoku Kinko Hyo
The Ichimoku Kinko Hyo is also one of the most used trend strength indicators. It can displays support and resistance level, momentum, and trend in one chart. However, there are five lines in the Ichimoku indicator. They are TenkanSen (Conversion Line), KijunSen (Base Line), Chiku Span (Lagging Span), Senkou A (Leading Span A), and Senkou B (Leading Span B).
The TenkanSen and the KijunSen are like moving averages (MA). TenkanSen is a shorter-term line, and KijunSen is a longer-term line. And, the area between Senkou A and Senkou B compose a cloud. During crossover, when TenkanSen rises above KijunSen, it generally indicates an uptrend. If that happens above the cloud, it also signals a strong uptrend. Conversely, If TenkanSen falls below KijunSen, it generally indicates a downtrend. If that occurs below the cloud, it also signals a strong downtrend. In the default setting, the calculations of those five lines are:
- TenkanSen (Conversion Line): (9-period high + 9-period low)/2KijunSen (Base Line): (26-period high + 26-period low)/2
- Chiku Span (Lagging Span): Price Close shifted back 26 periods
- Senkou A (Leading Span A): (TenkanSen + KijunSen)/2
- Senkou B (Leading Span B): (52-period high + 52-period low)/2)
McGinley Dynamic (MD)
Developed by John McGinley, McGinley Dynamic (MD) is a type of moving average that considered to be a price smoothing and trend strength indicator. It was designed to track the market better than existing traditional SMA and EMA. Moreover, it shows a smoother, more responsive, moving average line. Also, it minimizes price separation and price whipsaws. It has an automatic smoothing factor into its formula to adjust to market moves.
The calculation of the follows:
McGinley Dynamic Indicator (MD) = MD1 + (Price – MD1) / (N * (Price / MD1) ^ 4)
- MD1= value of the preceding period
- Price=Security’s current price
- N=number of periods
As mention above, MD is similar to the moving average. So, McGinley Dynamic can be used the same way as moving averages to identify the trend. Generally, When the price is above the MD line, it signals an uptrend. Conversely, When the price is below the MD line, it signals a downtrend.
People often question which one is the best trend indicator. But no indicator is better than others. Every indicator has advantages and disadvantages. However, the trader should choose indicators according to their trend trading strategy and personal preferences. Some traders frequently change indicators that can hamper their trading strategy. So, traders should stick with one or two trend indicators and become an expert at using it.
Think we have missed something? Let us know in the comment section below.