Trend Trading: The 4 Most Common Indicators

Successful traders often rely on a fundamental principle and longstanding piece of market wisdom: “The trend is your friend.” Indeed, history shows that financial markets generally maintain consistent directional movement, in one direction or the other, over the longer term even as price exhibits randomness in shorter time frames.

Trend trading is a strategy that seeks to capitalize on an asset’s directional momentum without trying to predict precise peaks and valleys—which is exceedingly difficult. Instead, trend traders concentrate on detecting and following recognized market trends.

Below, we consider four trend-trading indicators that have proven reliable over time.

Key Takeaways

• Trend trading focuses on market direction over the intermediate and long-term time frames.
• Moving averages filter market noise and signal reversals through crossovers.
• MACD reveals both direction and underlying momentum, including divergence, in a single indicator.
• RSI identifies sustainable pullback opportunities within trends and warns of weakening momentum.
• OBV instead considers volume as a leading indicator.

The Trend Is Your Friend

Studies confirm that trends appear and persist throughout financial markets. Research has documented continuous price momentum over prolonged periods. Studies also demonstrate that trend-following can produce positive returns across decades, and that longer-term movements follow directional patterns far beyond what random chance would allow.

Still, trends do not progress in direct, straight lines. They zig-zag and pause to consolidate. Short-term movements can indeed appear random and chaotic—so trend traders need tools to filter out market noise and protect their positions from temporary reversals.

Moving Averages

Moving averages are perhaps the most straightforward and widely used trend indicators. For instance, a 20-day moving average is calculated by averaging the closing prices of the previous 20 days. This generates a smoothing effect that enables traders to more quickly determine trend direction by eliminating the impact of short-term price changes and other market noise.

• Simple Moving Average (SMA): The SMA determines the average price for a specific duration by summing all closing prices and dividing the total by the periods’ number.
• Exponential Moving Average (EMA): The EMA assigns greater weight to recent price data, which means it responds more rapidly to new market information than the SMA.

Applications of Moving Averages

Trend identification: A rising price above a rising moving average indicates an uptrend in the given time frame, while a falling price below a falling moving average signals a downtrend.

Support and resistance levels: Moving averages often serve as support and resistance, where prices frequently reverse after pullbacks.

Crossover signals: A bullish “golden cross” emerges when a shorter-term moving average moves above a longer-term moving average. For example, a trend follower might look to go long when the 50-day EMA crosses above the 200-day EMA. In contrast, a “death cross” is bearish. That’s when a shorter-term moving average crosses below the longer term one.

Example:

Moving Averages

Moving averages are lagging indicators which means that they follow price and do not lead it.

In this chart, we can observe two significant moving average signals.

1. In December (downward arrow) the 20-day (orange line) falls beneath the 50-day (blue line) while prices are declining. The bearish crossover (“death cross”) accurately warns that prices are in an extended downward trend.
2. In August (the black upward arrow), the 20-day MA moves above the 50-day MA while prices increase, resulting in a “golden cross.” The bullish crossover serves as an indicator that confirms the recovery’s onset.

Throughout both trends, the moving averages also provide dynamic support and resistance, as the price tests these lines during retracements before proceeding.

These zones of support are further illustrated by the 20-day SMA shown below:

Moving Average Convergence Divergence (MACD)

The Moving Average Convergence Divergence (MACD) indicator uses moving averages together with momentum, providing both the strength and direction of market trends.

It consists of three complementary components:

1. MACD line: The difference between a 12-period EMA and a 26-period EMA.
2. Signal line: A subsequent 9-period EMA of the MACD Line. 
3. Histogram: Illustrates the divergence between the MACD line and the signal line.

Applications of MACD

Signal line crossovers: A bullish signal appears when the MACD line moves above the signal line, while a bearish signal emerges when the MACD line falls below the signal line.

Centerline crossovers: When the MACD line rises above zero it shows growing bullish strength, while its fall below zero implies strengthening bearish forces.

Divergence: A trend may be losing strength and approaching reversal when price records new highs or lows without confirmation via MACD highs or lows.

What You Need to Know

Traders frequently pair MACD with support and resistance candlestick charts for best results.

Example:

The chart displays multiple important MACD signals (displayed in the panel under price):

1. In late November (first downward arrow), the MACD line (orange) crosses below the signal line (blue) while both lines remain just above zero, signaling a resumption of bearish momentum.
2. In mid-December (first upward arrow), the MACD crosses above the signal line, signaling the strong uptrend that takes the price from $172 to $189.
3. The second downward arrow, in late January, shows a bearish crossover well above the zero line, signaling the beginning of a pullback to support around $172.
4. The final upward arrow appearing in February reveals a bullish crossover which confirms the subsequent rebound.

Throughout, the MACD histogram (vertical blue bars) confirms these trends through momentum variations. It broadens with strong market movements and shrinks when momentum fades ahead of reversals.

Relative Strength Index (RSI)

The Relative Strength Index (RSI) is a momentum oscillator that measures the speed of price movements on a scale from 0 to 100. While the RSI is perhaps better known for spotting overbought and oversold conditions, it also is also used to identify trend reversal points.

In the default settings, the RSI calculation applies a 14-period timeframe to measure average gains versus average losses: RSI = 100 – [100 / (1 + (Average Gain / Average Loss)].

Applications of RSI

Trend confirmation: The RSI generally fluctuates between 50 and 80 in strong uptrends and between 50 and 30 in strong downtrends.

Support and resistance levels: In addition to overbought and oversold levels, the RSI provides signals for market continuation or reversal.

Divergences: When prices hit new highs (or lows during a downtrend) but RSI doesn’t follow, it signals weakening momentum and a possible trend reversal.

Example:

This chart shows a stock transitioning from uptrend to downtrend with RSI providing key signals below the price chart.

1. In June, September, and October (upward arrows), the RSI bounces from near the 30 level, correctly identifying buying opportunities as the stock continues its uptrend.
2. In February (downward arrow), it shows bearish divergence—prices makes lower lows, but the RSI does not confirm, making a higher low. This signals a possible price reversal.

On-Balance Volume (OBV)

On-Balance Volume (OBV) focuses on volume rather than price alone. The premise is that volume often precedes price movement. OBV is therefore a leading indicator that can offer foresight ahead of price movements. 

OBV creates a running tally of trading activity, adding the current day’s volume when the closing price is higher than the previous day’s close, and subtracting it when the closing price is lower:

• If today’s close > yesterday’s:
  OBV = Previous OBV + Today’s Volume
• If today’s close < yesterday’s:
  OBV = Previous OBV – Today’s Volume
• If today’s close = yesterday’s:
  OBV = Previous OBV

Applications of OBV

Trend confirmation: When OBV rises/falls along with price, it validates the trend. OBV also forms its own trendlines whose breaks frequently precede corresponding price movements.

Divergence signals: When prices make new highs/lows but OBV doesn’t follow, it warns of potential trend reversals.

Breakout validation: Rising OBV during consolidation often precedes and confirms price breakouts, signaling early trend direction.

Example:

1. Above, we see a strong uptrend in price from April through February, confirmed by the steadily rising OBV trendline (orange) that climbs alongside price. This alignment between price and increasing volume validates the trend’s strength and sustainability.
2. The chart below shows OBV’s predictive capability for reversals. While prices continued rising from October to early January, reaching new highs around $41.50, the OBV line began showing bearish divergence in December (marked “Early warning”). This divergence—where price makes higher highs but OBV fails to confirm—accurately signaled the 15% reversal that followed.

The Bottom Line

Markets often follow prolonged directional trends. Trend traders focus not on predicting exactly when a trend will start or stop but on detecting established trends early enough to ride the momentum and to be alert to weakening trends to close the trade in time to protect profits. To succeed, trend traders need patience to wait for confirmation before entering the market and discipline to maintain positions through the duration of the trend.

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