Trend Confirmation

DoctorT

Hi!

I know that no one can predict the market. But, I believe that one can form an educated opinion about the market’s future directional bias.

Before trading vertical credit spreads, I would like to form an opinion about the short-term (i.e., 30-45 days) directional bias (i.e., bullish, sideways, or bearish) of the S&P 500.

To form the opinion, I can use one or more indicators. To start, I’ll use moving averages. For trend confirmation, I’ll use Ichimoku charts. And, I am looking for a third indicator to further confirm the trend. I looked at Bollinger bands, Keltner channels, regression channels, and parabolic SARs.

Which one would you use? Why?

Thank you!

Dr. T

markd

I haven't tried this myself, but intuitively, it seems promising.

If you look at the Chart School article on RSI, there is a section titled "Trend ID", where they explain Constance Brown's idea that RSI should find support in the 50-ish area if a bullish trend is in place and find resistance there if a bearish trend is in place.

In theory, markets are "fractal", that is, patterns found in one time frame should be valid in a larger or smaller time frame.

Since you want to use a relatively short time horizon, you might test whether her idea works on a 1 hour or 2 hour chart.

Similarly with MACD, Line above 0 all by itself suggests a generally bullish market. On a daily chart, it takes some time for Line to get below or above zero after price changes direction, so you would be late in or out, but using an intraday time frame should give you a heads up, although possibly also some whipsaws.

Another more complicated option is price and volume analysis to supplement your indicators.

The principle is, in an up trend, stronger volume should produce higher prices, and higher prices should attract new volume (vice versa in a down trend).

When strong volume (e.g. above the 21 day average, and greater than the previous bar) produces long wicks or tails, or very compressed range, or an open in the direction of the trend, but a close against the trend, it means prices are attracting a lot of counter trend interest (sellers in an up trend, buyers in a downtrend). If that happens once or twice, it may not be fatal but it is a warning that the trend psychology may be changing.

Conversely, if new prices occur on lighter volume, that means the trend is not attracting new converts, and counter trend players have a chance to move price against the trend.

But, it's an uphill battle (so to speak) to change the trend, and you can't be sure the trend has changed until 1 - trend players fail to respond to counter trend strength (e.g. in an up trend sellers make a lower low ( or just a deeper than usual down leg) but buyers can only make a lower high, not a new high) and 2 - counter trend players follow through (e.g. a second low below the first from that lower high). Note this is pretty much straight Dow theory.

DoctorT

Dear MarkD,

Thank you for your reply!

Often, I make things unnecessarily complicated. The RSI and the MACD are viable alternatives,

Dr. T