'The trend is your friend, until it bends' as the old saying goes, is one of truest market sayings of all time. Following the trend is the cornerstone of technical analysis and one of the surest ways to make money in the markets. Good trading systems usually involve getting into a trade in the direction of the long-term trend and waiting for the trend to produce a profit – as they say, 'the trend is your friend'... But there is another side to the old saying too; the trend is only your friend 'until it bends'. Trends can be notoriously fickle and often reverse on traders as soon as they've put their trades on. The best trends are therefore the strongest ones and the best markets to trade are the ones that tend to trend the strongest.
Detecting The Presence of a Trend,
An uptrend is defined as a series of higher highs and higher lows – a downtrend is defined as a series of lower highs and lower lows. Different trends exist on different time frames, however the best trends to trade are the ones where the trend is moving in the same direction on long, medium and short-term time frames. An uptrend on all time frames will usually result in the closing price of the day being higher than the price closed a short time ago, higher than it closed a moderate amount of time ago and higher than it closed a fairly long time ago. Likewise, a downtrend should normally result in the closing price being lower than the price closed a short amount of time ago, lower than it closed a moderate amount of time ago and lower than it closed a relatively long time ago. A simply way to detect if a market is trending in the same direction on short, medium and long-term time frames with simple technical analysis might be to compare the day's closing price with the closing price 120 days, 20 days and 8 days ago. If today's closing price is greater than closing price 8 days, 20 days and 120 days ago we would say the trend is up; if the closing price is lower than the closing price 8 days, 20 days and 120 days ago we would say the trend is down. If the day's closing price is greater than the closing price on some time frame(s) but less than the closing price on other time frames we could say there is no trend, or at least that there is a different trend on different time frames and therefore the trend is in doubt or not consistent – in these circumstances the longer term trend usually 'wins' with the shorter term trend(s) eventually shifting to the same direction of the longer term trend, but not always. So we can say the trend is at least in doubt if it is different on different time frames.
Measuring a Trends Strength,
During an up trend, the price would normally (on average) be expected to close nearer to the day's highest price than the day's lowest price.
If the price were to consistently close at the day's high then the price would be continually moving up, if the price were to consistently close at the day's low then the price would be continually moving down. So the stronger the trend, the nearer to the day's extreme high or low price we would expect to see the close.
We can therefore measure the strength of a market's trend by looking at the average position of the day's closing price in relation to the day's highest and lowest prices during a trending period.
The Experiment,
I'm going to test the 'trendiness' of the four large currency pairs (the EUR/USD, USD/JPY, GBP/USD and the USD/CHF) as well as the Canadian Dollar vs. the US Dollar. I will be testing to see how strong the market's trend is during trending periods only, which I define in this article as the day's closing price being above the closing price 8 days ago, above the closing price 20 days ago and above the closing price 120 days ago, or the day's closing price being below the closing price 8 days ago, 20 days ago and 120 days ago.
When the trend is up I will calculate the position of the closing price as a value between 0 and 100 with the formula (100/(High-Low))*(Close-Low) and then subtract 50 as the value should be above 50 during an up trend. When the trend is down I will calculate the position of the closing price as a value between 0 and 100 with the formula (100/(High-low))*(Close-Low) and then subtract 50 and change the negative number to a positive number by dividing it by –1 in order to make it comparable with the number we got testing the positive trend. This number will essential tell us how many percentage points (on average) the close deviates from the median value (50) by during the periods we have defined as trending. Each market's average result will then be used to indicate how well that particular currency pair trends.
To Recap –
If (Close > Close8DaysAgo AND Close > Close20DaysAgo AND Close > Close120DaysAgo) Then
Strength = ((100/(High-Low))*(Close-Low))-50
Else If (Close < Close8DaysAgo AND Close < Close20DaysAgo AND Close < Close120DaysAgo) Then
Strength = (((100/(High-Low))*(Close-Low)-50)*-1
Else Strength = Nothing
The Results,
The results are in, the GBP/USD and the EUR/USD currency pairs trend the strongest, with the USD/CHF not to far behind. The USD/CAD falls considerably behind the first 3 pairs and the USD/JPY falls even further behind that. The scores were –
Which market trends the best is a subject I'm very interested in, so if you can think of another way to test for the strength of the trend, or have any suggestions or improvements for me, please get in touch.
