These are lines drawn across successively higher bottoms in bullish markets moving up from lower left to top right , or successively lower tops in bearish markets moving down from upper left to bottom right. A bullish trend is indicated by a series of higher highs and higher lows, and a bearish trend, by lower highs and lower lows.
Look for three good tests of support or resistance. Breaking through a trend line is an important signal a trend is coming to an end. You can see the trend in a very basic chart of the crude oil futures contract.
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In this case, I am looking at a daily continuation chart. The key to determine whether this is in fact a solid bearish trend is to look for three tests of resistance. To the far right of the chart, we see a possible shift in the long-term trend. The market bounces to a key resistance point, then bounces without much follow through—trading in an up down, up, down pattern.
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We can see in this crude oil chart below how the market has stayed below the trend line from November until the time this article was published. A retracement is a significant price adjustment of an existing trend. Traders commonly focus on Fibonacci retracements , and the three main levels are 38 percent, 50 percent and 62 percent of a prior move. They are key levels that act as a gravitational pull.
Participants may also try to defend these levels for as long as possible to minimize their losses on positions. Looking at the crude oil chart again, I will add the Fibonacci retracements to it. You can see the move up from low at about As an oil trader, you would want to watch for a two-day close above the 38 percent retracement level which comes in around If this occurs, the market is likely to head higher and could push up to 50 percent retracement near The head and shoulders top is represented by three prominent peaks, while the bottom, three prominent lows.
The price retraced at the The Stochastics indicator is an oscillator that compares the actual price of a security to a range of prices over a certain period of time. The interpretation of the Stochastics indicator is quite similar to the RSI indicator: Traders look for overbought and oversold levels in Stochastics to determine whether to buy or sell a security.
However, unlike the RSI indicator where overbought and oversold levels appear at an indicator reading of 70 and 30 in default settings , respectively, when using the Stochastics indicator traders look at the 80 and 20 levels.
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Stochastics has similar disadvantages to RSI. While the indicator works great in ranging markets, it starts to return fake signals when markets start to trend. The Average Directional Movement Index, or ADX, is a trend-following indicator that can be used to determine both the direction and strength of the underlying trend. The ADX line is used to determine the strength of the trend: A reading above 25 usually signals a weak trend, readings between 25 and 50 signal a strong trend, and readings above 50 a very strong trend.
The ADX indicator is best used when day trading the market with a trend-following approach. If the reading reaches 25 or above, you could wait for pullbacks for example to an important Fibonacci level to enter into the direction of the underlying trend. The indicator can also be combined with oscillators to reduce the number of fake signals.
The Average True Range indicator ATR is a technical indicator that measures market volatility by taking the greatest of the following: the current high minus the current low, the absolute value of the current high minus the previous close, and the absolute value of the current low minus the previous close. The ATR indicator takes then the average of those values for a pre-specified period of time and plots them in the form of a moving average on the chart. As a measure of volatility, the ATR is often used by day traders for calculating their stop-loss levels.
As noted in the introduction, technical indicators use past price-data in their calculation and are therefore lagging the current price. However, since historical data is the only piece of information that traders have to anticipate future price movements, technical indicators do have an important role in a well-defined trading strategy.
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Avoid adding too many indicators to your chart as indicators of the same type usually return similar trading signals. Instead, choose only one indicator out of each group trend-following, momentum, and volatility and combine their signals to confirm a setup and trade based on it. An effective combination of indicators could be the moving averages, the RSI indicator, and the ATR indicator, for example.
Trend-following indicators will return a buy signal when prices start to move higher, even if the market is trading sideways. Similarly, oscillators and momentum indicators will give you a selling signal when prices start to rise during an uptrend.
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