Trend-following indicators are one of the most used and widely followed technical indicators available. They are mostly used to find out the trend and direction of the respective chart they are applied to.
The intrinsic nature of these indicators is to provide an actionable signal after a signal or trend reversal is underway. The above-mentioned quality, they are also termed as ‘lagging’ indicators.
Three primary uses for lagging or trend-following indicators are: first, they help a chartist/analyst in understanding the signals these indicators that are related to a developing trend or an impending reversal. Second, they provide data that give hints for long-term and short-term price prediction. Lastly, they help in expressing agreement with confirmation of identification of potential chart patterns or signals.
There are various useful trend-following indicators to grab hold of while studying charts.
Simple Moving Average (SMA)
An SMA collects the average price across a range of price bars in a given time frame and plots the collected data with the capability of being graphically understood.
An SMA tool is highly impactful in use when markets are trending upwards or downwards. They, by default, track the closing price of the underlying security or stock and generally present the strength of the underlying trend. For example, a price break below a 21-day SMA in an uptrend might mean unordinary weakness in a market while a price break above a 21-day SMA in a downtrend means unordinary strength in the market.
Exponential Moving Average (EMA)
This indicator is an advanced version of an SMA as it also involves average price points for the historical price bars but gives more weightage to the recent data points thereby it is called ‘weighted moving average’.
One short demerit of using giving more weight to recent data points is an increased number of false signals produced. To counter that demerit, it is generally advised by technicians to use EMA over a bunch of varying time frames to negate the effect of false signals.
Therefore, the direction and built of EMA help in finding out convergence/divergence signals that are pretty useful in trade management.
Average Directional Index (ADX)
This indicator helps in measuring the strength and weakness of an already active trend.
ADX used moving averages over multiple time frames to calculate three specific lines that run along with a panel from 0 to 100.
The lines are designated ‘ADX’, ‘+DMI’, and ‘-DMI’.
ADX here measures the strength of the upward trend when +DMI is above -DMI and ADX gives a quantifiable number between 25 and 100 to mark it as a strong trend and on the lower end of the spectrum if +DMI stays below -DMI with ADX below 25, the usefulness of the indicator isn’t much significant and may indicate lack of direction in the market or range-bound markets.
Moving Average Convergence-Divergence (MACD)
This indicator shows the relationship between two moving averages and the resultant reading is then plotted as a MACD line. Also, a 9-day EMA of the MACD line, known as ‘signal line’ is also posted above MACD which usually functions as a trigger for buy or sell signals.
Usually, MACD produced price convergences, divergences, and even sharp signals that sometimes become successful trades. Also, an MACD histogram is used to gauge the distance between the signal line and the MACD line. The histogram is a really useful visual aid in the identification of crossovers as they most often generate buy and sell signals.
Those were the most widely used trend-following indicators that help market participants get a deep understanding over the markets in terms of technical movements.
