Trend indicators can help traders spot potential market direction. Here's how to use three indicators on thinkorswim: moving averages, MACD, and Parabolic SAR.
Some traders, especially those using technical analysis in their trading, might focus on trends. And for good reason: Prices can change quickly, and some traders like to closely monitor trends and price changes. Trend identification can be a useful tool in finding entry and exit points.
Trends occur across all different time frames, and some traders believe the earlier a trend is spotted, the better the potential opportunity they have to capitalize on it. That’s easier said than done. The nice thing is there are many indicators traders can use to identify possible trends, such as linear regression, price envelopes, ADX, and Keltner channels. Three trend indicators we’ll discuss here include moving averages, moving average convergence divergence (MACD), and Parabolic SAR.
There are different types of moving averages. Two common types are the simple moving average (SMA) and exponential moving average (EMA).
An SMA is calculated by totaling the closing price of a security over a set period and then dividing that total by the number of time periods.
For example, the formula for a 10-period SMA would be:
The periods used for the calculation could be anything from minutes to years.
The SMA gives equal weighting to each time period, which may make it potentially well suited for identifying longer-term trends. If the security is above the moving average and the moving average has been going up, it’s could be an indication of an uptrend. If the stock is trading below an uptrending moving average, it may still be an uptrend, but it might potentially be weakening. A downtrend occurs when the price is below the moving average and the moving average is pointing down.
To add SMA indicators to the thinkorswim® platform, select the Charts tab and bring up a chart. Select Studies > Add study > Moving Averages. You’ll see a pretty extensive list of different types of moving averages. Select SimpleMovingAvg to plot the SMA on the chart. The default is the nine-period SMA. To change it, right-click the indicator line and select Edit study SimpleMovingAvg (CLOSE, 9, 0, no). From here, change the length to 50 and select OK. This will plot the 50-period SMA on the chart (see figure 1).
Another choice under the Moving Averages studies is the EMA, listed as MovAvgExponential. The EMA differs from the SMA in that its calculation assigns more weight to recent prices, making it potentially more responsive to short-term price action. As a result, the EMA tends to be used more than the SMA by short-term traders (see figure 2).
The type of moving average and time periods a trader might choose depends on their preferred trading style and time horizon. Traders could experiment with different indicators and strategies to determine what works best for their trade objectives.
The moving average convergence divergence indicator, or MACD, combines both trend identification and timing into one tool. The MACD belongs to a group of technical indicators called oscillators because they tend to move back and forth from one side to the other over a period of time.
The MACD is built on the idea that when moving averages begin to diverge from each other, momentum is generally thought to be increasing and a trend may potentially be starting. The creator of the MACD, Gerald Appel, recommends using the settings of 8 and 17 periods to enter a position on a daily chart but suggests a different combination (12 and 26 periods) for selling opportunities. The 9-period MACD average would apply to both. Of course, keeping Appel’s original intent in mind, the individual trader would need to decide how to use the MACD.
When the indicator line crosses above that signal line, it means an upward trend may be starting, and when it crosses below, it may signal the start of a downtrend. The MACD can also be plotted as a histogram. When bars are above the zero line, it indicates a potential upward trend, and when the bars are below the zero line, it could mean a downtrend. The two-line and histogram MACD is plotted in the subchart below the price chart (see figure 3). To add the MACD indicator to a chart, under the Charts tab on thinkorswim, select Studies> Add study> Momentum Studies> A-M> MACD.
The 12-26-9 configuration is the default setting on thinkorswim, but it’s possible to adjust the inputs depending on your trading preferences. Right-click the MACD indicator line, then select Edit study MACD. In the MACD Customizing window, change the input parameters and then select Apply.
Another potential thinkorswim indicator for a trend-finding arsenal is the Parabolic “stop and reverse” (SAR).
The Parabolic SAR indicator is designed so that when a security is in an uptrend, the indicator is plotted below the price in the form of a dot (see figure 4). This dot is the theoretical “stop” in the stop and reverse, the point at which (if the price touches it) the trend may have changed. When this happens, the Parabolic SAR is automatically plotted above the price, indicating a downtrend is in effect. Some traders use the Parabolic SAR to help determine where to place stop orders.
To add the Parabolic SAR to a chart, under the Charts tab on thinkorswim, select Studies> Add study> Upper Studies> M-P> ParabolicSAR.
As you can see from the chart above, the longer the Parabolic SAR is below (or above) the prevailing price, the stronger the trend may be. However, on short-term time frames, the Parabolic SAR may be more susceptible to false signals (what some traders call “whipsaws”). Like all trend-following thinkorswim indicators, the inputs for Parabolic SAR can be customized and used with any time frame.
Beyond these three technical trend analysis indicators, there are many other ways to identify and analyze trends in trading and investing. These studies can be used as stand-alone indicators or in conjunction with other indicators. Each trader should study these indicators to determine what will best serve their trading strategy.