Updated: Sep 22
Determining trend is the first thing I do when I look at a chart. Why? Playing on the right side of the trend will increase your probabilities significantly. Trend Analysis is key in almost every trading strategy though many interpret it differently based on their set of rules. My rules and process of determining trend is very simple and takes less than seconds to determine.
Let's take a look at the $SPY during 2011. Imagine the time, losses, and stress you would have had if you were trying to swing a long position while the market was in a downtrend. This is a classic example of lower highs and lower lows.
Now let's take a look at $SPY in 2014. Imagine the amount of stress you save yourself buying dips in a bullish trending market like this. Higher lows, higher highs. This is the most simple yet most important concept to understand about the market. This applies to any chart, company, sector, commodity, foreign currency, etc. If the trend is up, I want to participate long throughout that period. If the trend is down, I want to sit with cash or look for short positions to play in the direction trend.
When it comes to trading the trend I have a very specific set of rules to enter a trade:
Price > 55EMA
Buying above this EMA ensures I am in a bullish trend in the longer-term and intermediate-term of this stock's cycle. I like to see price greater than the 8, 21, and 34 EMAs unless buying a low-risk pullback to one of these EMAs or the 55EMA.
Price < 55EMA
Shorting below this EMA ensures I am in a bearish trend in the intermediate-term of this stock's cycle. I like to see price less than the 8, 21, and 34 EMAs unless shorting a low-risk pullback to one of these EMAs or the 55EMA.
How to visualize the trend on my charts using TrendSpider: Blue Ribbon: Bullish Trend
Red Ribbon: Bearish Trend
Why do I use the 8, 21, 34, 55, 89, 144, and 233 EMAs? These are Fibonacci numbers that have proven to be useful throughout all different types of technical analysis. Are Exponential Moving Averages better than Simple Moving Averages? My answer is I don't believe in much of a difference. I found when backtesting my EMAs that they tended to be more accurate but not with many discrepancies. Similar to being dealt a 16 in blackjack, you must decide for the rest of your life if you will choose to hit or stand because there is no noticeable difference in results. Can I just use one or two EMAs? Absolutely. Trading really comes down to executing a strategy that has proven to work in the past. If price typically does well above the 10EMA, trade accordingly. There is no secret formula. It is just about finding what works for you. In many cases (particularly short-term) I will just trade based off of the 8 and 21 EMAs to make things simple.