Incorporating Pattern and Countertrend Indicators

Among the oldest adages in all of trading is that "" the pattern is your buddy."" As the trend specifies the prevailing direction of price activity for a provided tradable safety, as long as it continues, more cash can be made by choosing the current trend than by battling versus it. It is instinctive to desire to acquire at the cheapest price and also to offer at the highest rate. The only way to do this in the financial markets is to attempt to "" purchase "the lower " and " offer the top, " which by definition is a countertrend method to trading. ( See also: 7 Tools of the Profession.)

Each trading day the struggle in between those trying to purchase or sell right into a well established pattern as well as those attempting to purchase near a low and offer near a high plays out. Both kinds of traders have really persuading disagreements regarding why their strategy is premium. Yet, remarkably, over time, among the most effective methods might simply entail combining these 2 relatively inconsonant techniques with each other. Usually, the basic solution is the best one.

A Combined Approach

Two actions assist to effectively incorporate trend-following as well as countertrend strategies:

  1. Identify a method that does a reasonably good job of identifying the longer-term trend
  2. Identify a countertrend method that does a good job of highlighting pullbacks within the longer-term trend

While locating an optimum strategy might take some time and also initiative, highlighting the potential usefulness of this concept can be done using some really straightforward techniques.

Step 1: Identify the Longer-Term Trend

In Figure 1 you see a stock graph with the 200-day moving average of shutting rates plotted. From a trend-following perspective we can simply mention that if the latest close is above the current 200-day moving standard, after that the pattern is "" up " as well as the other way around.

Combining Trend and Countertrend Indicators

Figure 1: Rate with 200-day moving average

Source: ProfitSource

However, for our purposes here we are not looking for a trend-following technique that will always set off real buy as well as sell signals. We are simply attempting to pin down the dominating fad. We will certainly now add a second trend-following filter. In Figure 2 you can see that we have actually likewise added the 10-day and also 30-day relocating averages.

Combining Trend and Countertrend Indicators

Figure 2: Price with 10-day, 30-day as well as 200-day moving standards

Resource: ProfitSource

So now our policies will be as follows:

  1. If the 10-day moving average is above the 30-day moving average AND the latest close is above the 200-day moving average, then we will designate the current trend as "up."
  2. If the 10-day moving average is below the 30-day moving average AND the latest close is below the 200-day moving average, then we will designate the current trend as "down." (See also: Exploring the Exponentially Weighted Moving Average.)

Step 2: Adding a Countertrend Indicator

There are literally lots and loads of prospective countertrend indicators that a person could select to utilize. For our purposes, considering that we are trying to find temporary pullbacks within a total longer term trend, we will make use of something very simple and relatively short-term in nature. This sign is just referred to as the oscillator. The computations are basic:

A = = the 3-day relocating average of shutting prices

B = = the 10-day relocating average of shutting prices

The oscillator is simply (A– B)

In Number 3, we see the same cost graph as in Figures 1 and 2 with the oscillator outlined below the rate activity. As the hidden protection dips in rate, the oscillator goes down listed below zero and the other way around.

Combining Trend and Countertrend Indicators

Number 3: Cost with 3/10 oscillator

Resource: ProfitSource

Step 3

So now let'' s really combine the two methods we have explained until now right into one method. In Number 4, see once again the exact same bar chart as in the previous three Figures. On this one we see the 10-day, 30-day and 200-day moving standards plotted on the price chart with the oscillator showed listed below.

Combining Trend and Countertrend Indicators

Figure 4: Trying to find oscillator reversals to the advantage in a well-known uptrend

Resource: ProfitSource

What an alert trader need to be searching for is circumstances when:

  1. The 10-day moving average is above the 30-day moving average
  2. The latest close is above the 200-day moving average
  3. Today's oscillator is above yesterday's oscillator AND
  4. Yesterday's oscillator value was both negative and below the oscillator value two days ago.

Completion of this set of standards recommends that a pullback within a longer-term uptrend might have been completed and also that costs could be readied to move greater. The previously mentioned requirements presents a situation in which the trend suggests that the stock is because of proceed its higher energy, yet the investor will certainly not be acquiring shares at the very peak of the cycle.

The Drawbacks

There are lots of prospective caveats connected with the method explained in this piece. Firstly is that no one must think that the defined method will generate regular trading profits. It is not offered as a trading system, only as an example of a possible trading-signal-generation technique. The technique itself is merely an example of just one way to combine trend-following and also countertrend signs right into one design. And while the principle is completely sound, an accountable investor would certainly need to evaluate out any type of approach prior to using it in the marketplace and risking real money. Furthermore, there are various other exceptionally essential factors to consider to take into consideration that work out beyond just producing entrance signals.

Other appropriate inquiries to ask as well as address prior to employing any trading approach are:

  • How will positions be sized?
  • What percentage of one's capital will be risked?
  • If and where to place a stop-loss order?
  • When should you take a profit?

The Bottom Line

This is simply a sampling of factors to consider that an investor need to take into account before beginning to trade any type of certain method. With those cautions strongly in mind, there does show up to be some quality in the suggestion of combining trend-following and countertrend approaches in an initiative to get at the most beneficial times while still adhering to the significant trend in play. (See also: Straightforward Relocating Averages Make Fads Stick Out.)

Tip: For investors’ reference only, it does not constitute investment advice. Financial investment products have high risks and are not suitable for every investor. If necessary, please consult a professional consultant.