In the last article, we looked at indicators on price. This week we try to answer one of the hardest questions in technical analysis. When is a market trending or ranging? Understanding what camp you are currently in will be crucial for your trading success. Many of the technical tools you will come across work better in the different periods of price action. We look in particular at one indicator; the Directional Movement Indicator (DMI), which tries to answer this question.
There are many ways to ascertain whether you think a market is trending or ranging. To start with you have to remember one very important statistic: Markets trend approximately only one third of the time
With this key bit of information locked away in the background of your analysis, you will get to appreciate that tools such as moving averages (a trend following approach) are going to be pretty useless two thirds of the time and it is therefore crucially important to recognise if the market is trending or ranging!
How can you identify a trending or ranging market?
The most simple approach is by very quickly visually analysing your charts - often it is very obvious if a market is moving up, down or sideways. After building up experience, this approach can be very effective. But, being analysts we want to quantify our subjectivity somehow. A lot of this objective quantification will come down to a rules based filtering system of analysis.
Rules based filtering analysis
You could use higher charting time frames to confirm whether the price is trending or ranging. If for example you are trading in the 30 minute charts, use the 4hr and 1 day charts to confirm the trend direction. If the trend / range is obvious in the higher time periods use that analysis in your trading window.
You can use other charting methods to determine the trend - for example, the Japanese charts: Kagi, Renko and 3 Line are all very helpful in determining if an asset is trending or ranging. Ichimoku as well - if the price is below the cloud price is bearish, above bullish and in the cloud neutral.
Moving Averages can also be used e.g. if the 20 moving average is above the 50 moving average is above the 200 moving average then this can determine a bullish trending environment. The angle of the trend in…
