## Three Indicators to Check Before the Trade

Trend direction and volatility are two variables an option trader relies on. Combining trend following, momentum, and trend reversal indicators on the thinkorswim platform may help you determine which direction prices may be moving and with how much momentum.

By Jayanthi Gopalakrishnan October 1, 2018 6 min read

6 min read

Photo by Dan Saelinger

#### Key Takeaways

- Choosing the right mix of indicators could potentially yield clues to direction and volatility
- Three categories of indicators to identify trend direction and momentum
- Use more than one indicator to help confirm if price is trending up, down or moving sideways

They say too many cooks spoil the broth. You can think of indicators the same way. Too many on a chart, and you won’t be able to make any sense of potential price direction. So which indicators should you consider adding to your charts?

Option contracts have a limited lifespan. So the challenge is to figure out which options will move within the lifespan of the options contract.

Options traders generally focus on volatility (vol) and trend. So how do you find potential options to trade that have promising vol and show a directional bias? This is where indicators may help.

### Not Just For Chart Geeks

No one indicator has all the answers. But throw a few together on a chart, and they may “indicate” if a stock is trending, which direction it’s trending, and with how much momentum.

Fire up your thinkorswim^{®} platform from TD Ameritrade, select the** Charts** tab, pull up any chart, choose the **Studies** option, then **Add Study**, and finally **All Studies**. You’ll see a long list. But you don’t need to know all about every single indicator. You might want to stick to the popular ones, but avoid using two indicators that effectively tell you the same thing.

Where to start? Keeping vol and directional bias in mind, let’s divide the indicators into categories.

### Indicator #1: Trend-Following Indicators

**Moving averages.** When you think “trend-following,” the first indicator that usually comes to mind is the moving average. It’s the line that goes through prices to show the general price movement. And there are different types: simple, exponential, weighted. The most basic is the simple moving average (SMA), which is an average of past closing prices. So, if you use a 50-day SMA, you’re looking at the average of the past 50 days. If you use a 20-week SMA, you’re seeing the average of the last 20 weeks.

The SMA’s main objective is to identify if price is in a possible trend and the trend’s direction. A quick glance at a chart can help answer those questions. In figure 1, it’s clear when a trend is going up or down. Remember, a trend can reverse at any time without notice.

**Moving average convergence/divergence (MACD).** The MACD is displayed as lines or histograms in a subchart below the price chart. We’ll focus on the line display, which is made up of two lines—the MACD line and signal line (see Figure 1). These two lines oscillate around the zero line. The MACD line, by default, is the difference between the 12- and 26-period exponential moving average (EMA) of the close. The signal line, by default, is the 9-period EMA of the MACD. You can change these parameters.

The MACD provides three signals—a trend signal, divergence signal, and timing signal. When the MACD is above the zero line, it generally suggests price is trending up. When it’s below the zero line, it suggests a downtrend. Crossovers can also be used to indicate uptrends and downtrends. When the MACD crosses above its signal line, prices are in an uptrend. The opposite is true for downtrends.

There’s another way you might use MACD—for divergence signals. That’s when price moves in one direction, but MACD moves in the opposite direction. A divergence could signal a potential trend change. But when will that change happen, and will it be a correction or a reversal? You may never get a perfect answer. But to get a possible idea, use the SMA and MACD together.

In figure 1, notice how price reacts to the SMA after the MACD divergence. Price broke through the SMA, after which a bearish trend started. Usually, you won’t see a divergence early in an uptrend. Instead, price, SMA, and MACD will probably move up. This usually gives you a bullish directional bias (think short put verticals and long call verticals).

Once a trend starts, watch it, as it may continue or change. Where are prices in the trend? How much steam does the trend have left? This is where momentum indicators come in.

**FIGURE 1: SMA AND MACD. **On your chart, try inserting the SimpleMovingAvg and MACDTwoLines studies. Here, the MACD divergence indicates a trend reversal may be coming. *Source: thinkorswim from TD Ameritrade. For illustrative purposes only.*

### Indicator #2: Momentum Indicators

To measure price momentum, you can examine where a stock’s price closed relative to previous closes or price ranges. Two common momentum indicators are stochastics and the Relative Strength Index (RSI).**Stochastics.** This is an oscillator that moves from zero to 100 and goes up and down with price. It’s derived from the closing price relative to the price range. If price rises and pushes the stochastic above 80, which is the “overbought” level, it suggests the trend may be losing steam, and prices could fall. In the same way, when price falls and the stochastic goes below 20, which is the oversold level, it suggests that selling may have dried up and price may rise.

**Relative Strength Index (RSI).** RSI looks at the strength of price relative to its closing price. It measures a security’s speed and the change in its price movements. A 10-period RSI will look at the prevailing closing price relative to the closing price of the prior 10 days. Like stochastics, RSI has overbought/oversold threshold levels—70 and 30, by default.

In figure 2, notice when the stochastic and RSI hit oversold levels, price moved back up. But both these momentum indicators can remain in overbought/oversold areas for extended time periods. So, how do you know when the trend could reverse?

**FIGURE 2: FINDING MOMENTUM.** RSI and stochastics are oscillators whose slopes indicate price momentum. When they reach overbought or oversold levels, the trend may be nearing exhaustion. *Source: thinkorswim from TD Ameritrade. For illustrative purposes only.*

### Indicator #3: Trend-Reversal Indicators

There’s no single indicator that can tell you a trend will reverse. But some have a combination of trend, momentum, and trend-reversal characteristics. The Bollinger Bands indicator falls into that category.**Bollinger Bands.** These bands can indicate a stock’s volatility. Bollinger Bands drape around prices like a channel, with an upper band and a lower band. Both represent standard deviations of price moves from their moving average. So a one-standard-deviation Bollinger Band means the bands cover 68% of price bars. Bollinger Bands of two standard deviations cover 95% of price bars, and so on. When you overlay two-standard-deviation Bollinger Bands on price bars, it means if price falls outside the bands, statistically they should stay outside the bands only about 5% of the time.

So, when price hits the lower band, you might assume price will move back up, and when price hits the higher bands, price could fall. But the stock’s price might move outside of the bands (see figure 3).

Sometimes you’ll see the bands contract or “squeeze.” When you see that happening, consider it a warning of a potential impending reversal. When price breaks out of the bands and it leads to an uptrend, prices may trade along the upper band. The opposite happens in a downtrend.

Bollinger Bands may also signal the slowing of a trend’s momentum. When a bullish trend slows down, the upper band starts to round out. But it’s what price does after the rounding out that could confirm it. If price approaches the mid-band, then moves toward the lower band, then moves along it, the trend has likely reversed.

### Finding the Right Mix

To see how this all works, suppose you select an indicator from each category—MACD for trend, RSI for momentum, and Bollinger Bands for trend reversal.

From the Charts tab, pull up a chart and enter a symbol, then add RSI, MACDTwoLines, and BollingerBands studies to your chart.

**FIGURE 3: MACD, RSI, AND BOLLINGER BANDS.** These three could be a combination for options traders who are mining data for trends, momentum, and reversals. *Source: thinkorswim from TD Ameritrade. For illustrative purposes only.*

### What Do the Indicators Reveal in Figure 3?

**1.** Bollinger Bands squeeze, bullish crossover in MACD, and RSI rapidly moving into overbought territory. Maybe it’s time to think about directional trades with a bullish bias.

**2.** Bollinger Bands start narrowing—upward trend could change. While prices are moving higher, MACD and RSI are moving lower. Momentum is slowing. Prices move within a tight range within the Bollinger Bands, and divergence between MACD and price suggests uptrend could reverse.

**3.** Bollinger Bands round out, price breaks through middle band toward the lower band, and breaks through it. Notice how prices move back to the lower band. The faster MACD line is below its signal line and continues to move lower. RSI also moves lower and hits “oversold” territory. All indicators confirm a downtrend with a lot of steam. Perhaps it’s time to consider putting on directional trades with a bearish bias, such as long put verticals or short call verticals.

### Not Bland, Not Spicy

It’s easy to see how indicators work on a chart in hindsight. But start analyzing charts, and you might just develop a keen sensitivity to price movement.

The market has a life of its own. And taken together, indicators may not be the secret sauce. But they can sometimes offer just the right amount of information to help you recognize and leverage directional bias and momentum.

*Jayanthi Gopalakrishnan is not a representative of TD Ameritrade, Inc. The material, views, and opinions expressed in this article are solely those of the author and may not be reflective of those held by TD Ameritrade, Inc.*

#### Key Takeaways

- Choosing the right mix of indicators could potentially yield clues to direction and volatility
- Three categories of indicators to identify trend direction and momentum
- Use more than one indicator to help confirm if price is trending up, down or moving sideways

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## CorrelationTrendIndicator

### Description

Correlation Trend Indicator is a study that estimates the current direction and strength of a trend. It can be used to detect trend outbreaks or exhaustion. Correlation Trend Indicator uses Spearman correlation when estimating how closely the behavior of close prices correlates with a positive-slope straight line. This means that:

- Values close to +1.0 signify uptrend conditions.
- Values close to -1.0 signify downtrend conditions.
- Values around 0.0 signify sideways-trend conditions.

### Input Parameters

Parameter | Description |
---|---|

The projected trend length. |

### Plots

Plot | Description |
---|---|

The CorrelationTrendIndicator plot. | |

The zero level. |

Example*

*For illustrative purposes only. Not a recommendation of a specific security or investment strategy.

## TTM_Trend

### Description

The TTM_Trend study is intended to indicate the true direction of the trend replacing false signals with true ones.

The TTM_Trend study converts the normal chart to the view where irregularities are eliminated. In TTM_Trend, a bar is shown as bearish when the Average Price has closed in the lower 50% price range of the input-defined number of previous bars. If the Average Price has otherwise closed in the upper 50% range, the bar is shown as bullish.

### Input Parameters

Parameter | Description |
---|---|

The number of bars to calculate the price range. | |

Defines whether or not to paint bars according to the algorithm (blue for bullish trend, red for bearish trend). |

### Plots

Plot | Description |
---|---|

The Trend Up plot. | |

The Trend Down plot. |

### Example*

*For illustrative purposes only. Not a recommendation of a specific security or investment strategy.

## Let’s Get Technical: 3 thinkorswim® Indicators to Help Find and Follow Trends

How can you spot a market trend? Try several trend-following technical indicators. Three of the more popular ones are moving averages, MACD, and Parabolic SAR.

By John McNichol January 5, 2021 6 min read

6 min read

Photo by Getty Images

#### Key Takeaways

- Three popular trend-following indicators are moving averages, moving average convergence divergence (MACD), and Parabolic SAR
Get to know trend-following indicators by experimenting with different ones

- Trend-following indicators can be used on their own or combined with other indicators

Many traders, especially those using technical analysis in their trading, often focus on trends. And for good reason: Prices are constantly changing, sometimes very quickly. Traders like to catch these changing prices hoping to ride them out, regardless of whether they’re short- or long-lived. Trend identification is so popular that there are many sayings related to trends, such as:

- Don’t fight the trend.
- The trend is your friend.
- The trend is your friend until the end when it bends.

But how do you find the trend in the first place?

Pull up a chart of the **Dow Jones Industrial Average **($DJI) for the last 100 years and it’s easy to spot the overriding trend—up—but that’s not necessarily going to help you trade or manage your portfolio. In that 100-year period, there have been numerous uptrends and downtrends, some lasting years and even decades.

Trends occur across all different time frames, and it’s often said the earlier you spot a trend, the more opportunity you may have to capitalize on it. But that’s easier said than done. The nice thing is there are many indicators you can use to identify possible trends, such as linear regression, price envelopes, ADX, and Keltner channels. Three of the more popular ones are moving averages, moving average convergence divergence (MACD), and Parabolic SAR.

### 1. Moving Averages

A moving average is one of the more popular ways to identify a trend, but there are different types. And not all moving averages are created equal. Two of the more common types of moving averages 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 calculation for a 10-period SMA would be as follows:

- CP = closing price
- Number = period
- SMA = (CP1 + CP2 + CP3 + CP4 + CP5 + CP6 + CP7 + CP8 +CP9 + CP10) / 10

The periods used for the calculation could be anything from minutes to years.

The SMA gives equal weighting to each time period, which makes it well suited for identifying longer-term trends. If the security is above the moving average and the moving average is going up, it’s an indication of an uptrend. If the stock is trading below an uptrending moving average, it’s still an uptrend, but it might be weakening. A downtrend occurs when the price is below the moving average and the moving average is pointing down.

Adding indicators to the thinkorswim platform from TD Ameritrade is a breeze. Say you want to overlay an SMA on a price chart. From the **Charts** tab, bring up a chart. Select **Studies** > **Add study** > **Moving Averages**. You’ll see a pretty extensive list of the different types of moving averages. Select **SimpleMovingAvg** and you’ll see the SMA plotted on the chart. The default is the nine-period SMA. To change it, select the indicator, then **Edit study SimpleMovingAvg (CLOSE, 9, 0, no)** and change length to 50. This will plot the 50-period SMA on the chart (see figure 1).

**FIGURE 1: SPX WITH 50-DAY SMA.** On this chart of the **S&P 500 Index** (SPX) with the 50-day simple moving average (SMA) overlaid on it (purple), the overall trend looks to be up. If price fell below the moving average, it’d be an indication the index is getting weaker. Chart source: the thinkorswim platform from TD Ameritrade. *For illustrative purposes only. Past performance does not guarantee future results.*

One of the choices under the **Moving Averages** thinkorswim 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 more responsive to short-term price action. Thus, the EMA tends to be favored among many short-term traders. Try adding the EMA on an intraday chart (see figure 2).

**FIGURE 2: SPX 10-MIN INTRADAY CHART WITH 10-MIN EMA.** In this intraday chart of the SPX, you can see a 10-minute exponential moving average (blue). Because the more recent prices have a higher weighting, the EMA tends to adjust to price action quicker than an SMA. Chart source: the thinkorswim platform from TD Ameritrade. *For illustrative purposes only. Past performance does not guarantee future results.*

The type of moving average and time periods you might choose will depend on your preferred trading style and time horizon, so you might want to experiment with them to see which is optimal for your purposes.

### 2. Moving Average Convergence Divergence

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 be starting. Traditionally, the MACD takes two EMAs—the 12 and 26 period—subtracts the shorter from the longer, and plots it on a chart.

Then a 9-period average of the MACD itself is plotted, thereby creating a signal line. When that signal line crosses above the indicator 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 an upward trend, and when the bars are below the zero line, it could mean a downtrend. In the chart in figure 3, the two-line and histogram MACD is plotted in the subchart below the price chart.

**FIGURE 3: APPLYING THE MACD.** The moving average convergence divergence (MACD) indicator is plotted in a subchart below the stock chart as two lines and a histogram. As the signal line (blue) crosses above and below the indicator line (yellow) and the histogram bars move above and below the zero line, you may be able to identify potential trend changes. Chart source: the thinkorswim platform from TD Ameritrade. *For illustrative purposes only. Past performance does not guarantee future results.*

The 12-26-9 configuration is the default setting in thinkorswim, but you can go in and adjust the inputs, depending on your trading preferences. Just select the indicator, then **Edit study MACD**. In the **MACD Customizing **window, change the input parameters and then select **Apply**.

### 3. Parabolic SAR

Another potential thinkorswim indicator for your trend-finding arsenal, especially for swing traders, is the Parabolic SAR.

The “SAR” in Parabolic SAR stands for “stop and reverse,” and the 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 SAR is then automatically plotted above the price, indicating a downtrend is in effect. Some traders use the Parabolic SAR to help them determine where to place stop orders.

**FIGURE 4: USING PARABOLIC SAR TO IDENTIFY TRENDS. **The Parabolic SAR, plotted as a yellow dot above or below the daily close, indicates trend direction. A series of dots below the price bars indicates an uptrend, whereas a series of dots above the price bars indicates a downtrend. When the price moves below or above these dots, it could indicate a change in trend direction. Chart source: the thinkorswim platform from TD Ameritrade. *For illustrative purposes only. Past performance does not guarantee future results.*

As you can see from figure 4, the longer the 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 the Parabolic SAR can be customized and used with any time frame.

These are just a few of the thinkorswim studies you can choose from when trying to identify and analyze trends in your trading and investing. They can be used as stand-alone indicators or in conjunction with others. But however you wish to use them, make sure you take the time to familiarize yourself with each to find the strategy that works best for you.

Getting Started with Technical Analysis

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#### Key Takeaways

- Three popular trend-following indicators are moving averages, moving average convergence divergence (MACD), and Parabolic SAR
Get to know trend-following indicators by experimenting with different ones

- Trend-following indicators can be used on their own or combined with other indicators

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## Trend indicator thinkorswim

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4 Best Day Trading Indicators You NEED to Use (ThinkorSwim).

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