Defining the trend: structure, moving averages and the leader filter

Updated

What you will learn

  • Define an uptrend by swing structure and by moving-average slope and order.
  • Apply the eight checks of the leader trend filter and explain the purpose of each.
  • Read the RS line and tell relative strength from absolute strength.

A trend-following system can only follow a trend it can define. "The stock looks strong" is not a rule. This lesson gives three objective ways to define an uptrend: the structure of swing highs and lows, the slope and order of moving averages, and strength relative to the market. Combined, they form a leader trend filter: a short list of stocks worth watching for the breakout entries in the following lessons.

Trend as price structure

The oldest definition comes from Charles Dow's work at the end of the nineteenth century: an uptrend is a series of higher swing highs and higher swing lows. Each rally pushes past the previous peak, and each pullback stops above the previous trough. The trend is intact until price breaks that pattern, most clearly with a close below the last higher low.

Uptrend defined by swing highs and lowsA zigzag price path makes three higher highs and three higher lows, then falls below the last higher low and makes lower highs, which ends the uptrend structure.HHHLHHHLHHHLLHLHLast higher lowClose below the last higher low:the uptrend structure is brokenUptrend: each rally makes a higher high,each pullback holds above the last low
The structural definition of a trend: the uptrend is intact while pullbacks hold above the previous swing low.

Structure is the most intuitive definition and the one a trader sees first on a chart. Its weakness for systematic trading is that it depends on what counts as a swing: a three-day wiggle and a six-week correction are both swings at different scales. Rules therefore usually turn structure into numbers, such as the highest high or lowest low of the last n sessions, which is exactly what channel breakouts do in lesson 3.

Trend as moving averages

Moving averages turn the trend into something measurable: the average's slope shows its direction, and the order of averages of different lengths shows whether short-term and long-term trends agree. Three conditions describe a healthy long-term uptrend:

  • price above the 200-day average, the most widely watched long-term line;
  • the 200-day average itself rising, not just price above it;
  • the averages stacked in order: price above the 50-day, the 50-day above the 150-day and the 150-day above the 200-day.

A rising 200-day matters because price can sit above a falling average during a bear-market rally. The stack matters because it shows that recent buyers are in profit at every time scale, so there is little overhead supply from trapped holders. How each average is calculated, and the trade-off between simple and exponential averages, is covered in moving averages.

The leader trend filter

Mark Minervini published a widely used checklist of this kind in Trade Like a Stock Market Wizard (2013). Clear Tape's Leader Trend Filter preset is based on it, and requires all eight of the following at the close:

  1. The close is above the 150-day and the 200-day simple moving average.
  2. The 150-day average is above the 200-day average.
  3. The 200-day average is higher than 21 sessions (about a month) ago.
  4. The 50-day average is above both the 150-day and the 200-day.
  5. The close is above the 50-day average.
  6. The close is at least 30% above the lowest low of the last 252 sessions (52 weeks).
  7. The close is no more than 25% below the highest high of the last 252 sessions.
  8. The stock's price change over the last 126 sessions (6 months) and over the last 252 sessions (12 months) both beat SPY's.

Each check has a job. The first five confirm a long-term uptrend with the intermediate trend in agreement. The sixth ensures the stock has already proven it can rise substantially off its low, rather than merely bouncing. The seventh keeps the stock near its highs, where there are few disappointed holders waiting to sell. The eighth asks for leadership: the stock must be doing better than the market, not just rising with it.

Moving averages lining up as a stock becomes a leaderA price line with its 50, 150 and 200 day simple moving averages. At first the averages are tangled and the 200-day falls; later price is above a rising 50-day, which is above the 150-day and the 200-day, and the shaded area marks the days that pass the trend checks.$40$50$60$7050-day150-day200-dayPriceAverages tangled,200-day fallingAll trend checks pass:price > 50 > 150 > 200, 200 rising
Computed on an illustrative price path. The shaded days meet the moving-average and 52-week range checks; the relative-strength check is shown in the next figure.

Two cautions. First, this is a filter, not an entry. A stock that passes can be extended far above its averages, and buying the moment it qualifies often means buying after a large move. The filter tells you where to look; the entry rules in lessons 3 and 4 tell you when to act. Second, late in a bull market many stocks pass shortly before they top, so the filter works best when the broad market is itself in an uptrend.

Relative strength: leaders, not just risers

In a rising market almost everything rises. Leaders rise faster and fall less. The simplest way to see this is the RS line: the stock's price divided by an index such as SPY. When the line rises, the stock is outperforming; when it falls, it lags, even if its price is going up.

Relative strength line leading priceTwo panels. The top shows a stock price that dips and later breaks above its prior high. The bottom shows the stock divided by SPY, which reaches a new high first, while the price is still below its prior high.Stock priceRS line = stock ÷ SPYPrior price highPrior RS highRS line at a new high while priceis still below its prior highPrice followsMarket sells off; the stock holds up
Illustrative. A stock that holds up during a market decline shows rising relative strength; an RS high ahead of a price high is a common trait of future leaders.

A pattern many growth traders watch is an RS line that reaches a new 52-week high while the price is still below its own high. It means the stock held up during the market's weakness and is ready to lead when the market turns. The reverse also matters: relative strength is not absolute strength. In a sell-off, a defensive stock can make RS highs while its price falls. For RS ratings and their limits, see relative strength.

The market comes first

Most stocks follow the market, and breakouts fail far more often when the index is in a correction. A simple regime check before acting on any signal: is SPY above a rising 200-day average, and are more stocks making new highs than new lows? Market breadth explains the second test. The presets in this course do not apply a market filter themselves, so this check is yours to make, for example by taking fewer or smaller positions when the index is below its 200-day average.

How to apply it

Entry

Use the trend definition as a gate, not a trigger. Only stocks that pass all eight checks, ideally with an RS line near its high, go on the watchlist for breakout entries. No new long positions in stocks that fail the filter.

Stop

The filter itself has no stop. Once a breakout entry is taken, its own stop applies; where the filter is used as a system in its own right, the preset uses an ATR trailing stop (see below).

Target

None. A stock stays a candidate as long as it passes.

Invalidation

Any check failing at a close removes the stock from the list: most often a close below the 50-day average or a fall of more than 25% from the high. Structurally, a close below the last higher low says the same thing.

In Clear Tape

The Leader Trend Filter is one of the five presets switched on by default on the Trading systems page. It signals on the first close at which all eight checks pass after at least one failed the session before, so each stock is flagged once, on the day it newly qualifies. It needs at least 260 sessions of history and SPY's prices for check 8. Note one difference from the book: the published eighth check is a relative-strength rank of 70 or more against all stocks; because a rank needs a ranked universe, the preset asks instead that the stock beat SPY over both 6 and 12 months. As a system, it uses an ATR trailing stop (the highest high of the last 22 sessions minus 3 × ATR(22), only ever moving up) and exits when any check fails at a close. For the RS line itself there is a separate RS New High preset, which flags a new 52-week high in the stock-to-SPY ratio. Watchlist screening and backtests are available to Tools and Pro members.

Common mistakes

  • Treating "above the 200-day" as an uptrend while the 200-day is still falling.
  • Buying the day a stock first passes the filter, without an entry setup or a stop.
  • Confusing relative strength with absolute strength in a falling market.
  • Ignoring the market: running a long-only trend filter through an index downtrend.
  • Loosening the checks to find more candidates when few stocks pass; a short list is information about the market.

Summary

An uptrend can be defined by structure (higher highs and higher lows), by moving averages (price above a rising, correctly stacked set of averages) and by relative strength (outperforming the index). The eight-check leader trend filter combines all three into an objective list of candidates. It decides where to look, not when to buy; that is the job of the breakout entries in the next lesson.

For educational purposes only. Not investment advice.

Check your understanding

Answer each question to see the explanation. Answers are not saved.

  1. A stock closes above its 50-, 150- and 200-day averages, which are stacked 50 > 150 > 200. The 200-day average is slightly lower than it was 21 sessions ago. Does it pass the leader trend filter?

    1. A Yes: the averages are stacked correctly, which is what matters
    2. B No: the 200-day must be higher than 21 sessions ago
    3. C Yes, as long as the close is above the 200-day average
    Show the answer

    Answer: B. Check 3 requires the 200-day average to be higher than 21 sessions ago. Price above a falling 200-day can be a bear-market rally.

  2. A stock closes at $60. Its 52-week high is $90 and its 52-week low is $40. Which of the 52-week range checks does it fail?

    1. A Neither: it is 50% above its low and so qualifies
    2. B At least 30% above the 52-week low
    3. C Both 52-week range checks
    4. D No more than 25% below the 52-week high
    Show the answer

    Answer: D. $60 is above 1.3 × $40 = $52, so the low check passes, but it is below 0.75 × $90 = $67.50. The stock is 33% off its high, too far for a leader.

  3. An uptrend has made swing highs at $50, $55 and $58 and swing lows at $46 and $50. Price now closes at $49. What does the structural definition say?

    1. A The uptrend is intact because $49 is above the first low of $46
    2. B Nothing can be said until the stock makes a new swing high
    3. C Broken: the close is below the last higher low of $50
    Show the answer

    Answer: C. Under the structural definition the trend is intact while pullbacks hold above the most recent higher low. A close below $50 breaks the sequence.

  4. Over two weeks SPY falls 8% and a stock falls 3%. What does the stock’s RS line show, and what follows?

    1. A It rises: the stock outperforms, a reason to watch, not yet to buy
    2. B The RS line falls, because the stock’s price fell
    3. C The RS line rises, so the stock is in an uptrend and should be bought now
    4. D The RS line is unchanged, because both fell
    Show the answer

    Answer: A. The ratio of stock to SPY rises when the stock falls less. Relative strength is not absolute strength, so a trend and an entry signal are still needed.

  5. Late in a long bull market, the Leader Trend Filter flags a stock that is already 35% above its 50-day average. What is the most sensible use of the signal?

    1. A Buy at the next open, since all eight checks pass and the trend is confirmed
    2. B Ignore it: the filter does not work late in bull markets
    3. C Short the stock, because it is extended
    4. D Add it to the watchlist and wait for a defined entry and stop
    Show the answer

    Answer: D. The filter says where to look, not when to buy, and an extended stock offers a poor entry. A later base and breakout gives a defined stop and better risk.

  6. A stock passes the first seven checks. Over the last 6 months it beat SPY, but over the last 12 months it lagged SPY. What does the Clear Tape preset decide?

    1. A It passes, because the recent 6 months matter more
    2. B It fails: it must beat SPY over both 126 and 252 sessions
    3. C It passes if its relative-strength rank against all stocks is above 70
    Show the answer

    Answer: B. Check 8 in the preset needs outperformance over both 6 and 12 months. The preset uses this in place of the book’s rank of 70, which needs a ranked universe.

Strategies built on this lesson

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