Trend trading has been an extremely popular approach to making money in the markets for as long as trading has been documented. Even those who don’t consider themselves primarily trend traders often consider the trend as part of their market analysis. With so many people looking at market trends, the question, “Exactly how do you determine and measure the trend of any given market?” naturally arises. You can choose from three basic approaches: discretionary analysis, higher highs and higher lows, and the 50-period simple moving average.
Discretionary analysis involves eye-balling a chart and subjectively determining whether the market looks like it’s moving up or down. The overall direction of a market may seem obvious with a simple look and not require overanalysis.
The problem with this approach is that without an objective method for measuring the trend, it’s impossible to build a rule-based trading methodology around it, which has the domino effect of making your entire trading methodology subjective. Unless your trading method is objective, you won’t be able to test it with accuracy over time to determine whether it’s a viable method.
Higher highs and higher lows
An extremely popular approach to defining an uptrend is a market chart price pattern that exhibits higher highs and higher lows. Conversely, a downtrend is identified by a price pattern that shows lower highs and lower lows.
This definition suffers from the disadvantage of not properly defining the word trend, which is a long-term move. To support this, traditional technical analysis identifies a “complex retrace” pattern that could be a short-term lower swing high and lower swing low as a short-term correction against a long-term uptrend.
The 50-period simple moving average
Moving averages of various lengths have long been employed as trend-following indicators. New traders often like to use short-term moving averages because they follow price more closely. They may have their uses, but because the trend is the long-term direction of the market, a short-term moving average isn’t appropriate to measure trend.
The 50-period moving average and the 200-period moving average are traditionally two of the most commonly used moving averages. For this reason, they have the advantage of providing a “self-fulfilling prophecy.” Mass numbers of market participants watching such moving averages results in mass numbers of people responding to them.
Consider including both of these moving averages on all your charts, but the 200 moving average may be too slow of a trend indicator for your taste. You can use it for support and resistance levels, but you may want to rely on the 50 moving average to measure trend.