Trending and Ranging Markets – Part 2
In the first part of “trending and ranging markets”, we defined and identified what trending and ranging markets were. In this blog post, we shall elaborate further on how to identify each type of market, using some tools and indicators at our disposal.
Before we go on to talk about how to identify trends, let us mention a point that is often neglected. What is the best time frame to use to determine a trend?
A genuine trend is one that has been on for a few days at best. You cannot determine a trend by what transpires over fifteen minutes or a few hours. As such, using a 15minute chart or a one hour chart will not give the trader an accurate depiction of a trend. The best charts to use for trend determination are the long term time frames, starting from the Daily chart. A typical daily chart will tell the trader how the market has been operating for at least, a few trading weeks.
Take a look at the chart of the DJ30 (Dow Jones) futures. It shows the market in an unmistakable uptrend from August 2010 to May 2011. This is a clear trend movement lasting 9 months. If a short term time frame had been used, the true trend would not have been obvious to the trader. This underscores the importance of always looking at the big picture when trying to determine trends.
Now that we have cleared the air on what time frame to use in determining trends, let us now proceed to discuss how to determine the trend correctly.
Useful technical indicators
- Bollinger Bands
- MACD Histogram
- Welles-Wilder ADX (Simple ADX works as well)
The first method we mentioned in part 1 of this topic was used for the chart above. The flow of the Bollinger bands easily tells us where the trend is headed.
Another indicator that can be used to determine the trend is the MACD histogram. The MACD operates by crossing from negative to positive when there is an uptrend change, and from positive to negative when there is a downtrend change. If the histogram is near zero for a period of time, this is an indication that the market is ranging.
The Welles-Wilder’s ADX indicator is a custom indicator that is used to differentiate between ranging and trending markets. The direction as well as the rate of change of the ADX line is usually used as the defining factor for this differentiation.
On a final note, we need to state here that determining a trend is something that is more easily done on hindsight. Most of the time, a trader will find it hard to detect the prevailing trend or indeed, the future trend in a real-time situation. The indicators mentioned above are all lagging indicators and cannot be accurately used to determine the momentum of the trend. Trying to use them on a standalone basis will lead to late trade entries. Even with ranging markets where the trader can see that the market has been ranging for some time, a market even such as a high impact news release can easily turn a ranging market into a trending one.
In order to bypass these restrictions, we have come up with a powerful tool for traders to use: FX Pulse.
FX Pulse is designed to inform traders about the trend, and the strength/momentum of that trend. The trend detector color-coded squares also tell the trader when there is trend agreement on several time frames, something that is very useful to traders who use multiple time charts to confirm entries.
Screenshot of FX Pulse
FX Pulse can be used on all MT4 platforms (free), you can download it here.
Note: Actual version is not 100% perfect, sometimes it stuck for a half second when you change time frames but my programmer should have this fixed soon. More information about Fx Pulse can be found here.
P.S.: I will post more “need to know” knowledge soon. So make sure you don’t miss it by subscribing to my blog.