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The index trend filter

Lesson 5 · about 9 min

Most swing trades are long, and most long swing trades in individual stocks rise and fall with the index. Studies of stock returns consistently attribute a large share of any single stock's daily move to the market and its sector rather than to the company. So the first question every weekend is not "which stock?" but "should I be long anything at all?" A trend filter on the index answers that in thirty seconds.

The filter

Use the daily chart of the broad index you trade against: an S&P 500 or Nasdaq-100 proxy for US stocks, the relevant national index elsewhere, BTC for crypto majors, the dollar index for forex. Plot the 50-day and 200-day simple moving averages.

Condition Regime label What you may do
Price > 50 MA > 200 MA, both rising Uptrend Full long book, all setups allowed
Price > 200 MA, but below or chopping at 50 Correction Half size, pullback and reclaim setups only
Price < 200 MA, 50 MA falling Downtrend No new longs in stocks; shorts or cash; hedged only
50 crosses above 200 after a downtrend Early recovery Test longs at half size, tighten if they fail 
Uptrend                          Downtrend
                    ___/           \___
              ___/  50MA               \___  50MA
        ___/                                \___
  ___/  200MA                    ‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾‾  200MA
                                              \___
price above both, both rising    price below both, 50 rolling over

The labels are deliberately coarse. The filter is not trying to forecast; it is trying to stop you from fighting a market that is obviously going the other way.

Why the 50 and 200

They are not magic. They are widely watched, which makes them self-reinforcing to a degree, and they represent roughly a quarter and a year of trading days, which are the timescales over which institutional money reallocates. You could use 40 and 150 and get nearly the same signals. What matters is having one fixed pair and never changing it mid-drawdown to make the current regime look better.

What the filter is for

Look at what happens to an ordinary breakout setup across regimes. These numbers are illustrative of the pattern most traders find when they tag their journal by regime, not results from a particular study:

Regime Breakout follow-through rate Average R
Uptrend Higher Positive
Correction Lower Around 0
Downtrend Poor Negative

Same setup, same trader, same stop rules. The difference is the tide. Trading breakouts in a downtrend is not a slightly worse version of trading them in an uptrend; it is a different and losing activity.

Key idea: The index trend filter does not tell you what to buy. It tells you whether buying is allowed this week, and at what size.

The three rules

  1. Check the filter before the scan, every weekend. If the regime says no new longs, do not run the long scans. You will find candidates anyway, and finding them is how you end up in them.
  2. Size by regime, not by conviction. Full size in an uptrend, half in a correction, zero new stock longs in a downtrend. Write those fractions down.
  3. Change the label only on a weekly close. A daily close below the 50 MA on Wednesday does not flip the regime. Re-evaluate on the weekend with the weekly bar complete. This stops you from whipsawing your whole book on one bad day.

Handling the edges

  • Price sitting on the 50 MA. This is the correction label by definition. It is the most common regime and the most frustrating, because trends resume from here and also fail from here. Half size covers both possibilities.
  • 200 MA flat, 50 MA whipping around it. A rangebound market. Breakouts fail; mean reversion to the 20 MA (Module 4, lesson 4) works. Label it correction and lean on that setup.
  • Index in an uptrend, your sector in a downtrend. The index filter is a necessary condition, not a sufficient one. Sector rotation, covered in lesson 3, is the second gate.

For non-stock markets

Futures traders on indices use the same chart. Forex traders apply the filter to the pair itself, since there is no "index" of a currency pair beyond the dollar index as a rough guide. Crypto traders use BTC as the market and apply the filter to it before touching anything smaller; altcoins in a BTC downtrend behave like small caps in a bear market, only faster.

Try it: Pull up your index on a daily chart with the 50 and 200 SMA. Scroll back two years and label each month with one of the four regime labels. Count how many months were uptrend. That fraction is roughly the share of the year you should expect to be fully invested.

Recap

  • Check the index before anything else; most stocks follow it.
  • Price above a rising 50 MA above a rising 200 MA is an uptrend and allows a full long book.
  • Between the averages is a correction: half size, pullbacks and reclaims only.
  • Below a falling 200 MA is a downtrend: no new stock longs.
  • Relabel only on weekly closes and never change the average lengths to flatter the current tape.

See it drawn

Original diagrams for the ideas on this page. Illustrative, not real market data.

Trend structure: higher highs against lower lowsTwo zigzag price paths side by side; the left one steps upward with each peak and trough above the last, the right one steps downward with each peak and trough below the last.UPTRENDhigher highs, higher lowsHHHHHHHLHLHLDOWNTRENDlower highs, lower lowsLHLHLHLLLLLLHH higher high, HL higher low, LH lower high, LL lower low.
How a trend is built. A trend is just a sequence of turning points. While each peak and each dip sits above the one before it the market is trending up; once both start landing below the previous ones the structure has turned down.
Breakout and retestPrice stalls under one level, pushes above it, comes back to touch it from above, then continues higher.pricetimeold resistancenow support1price keeps stalling2breaks above3pulls back and retests it4and carries on
Breakout and retest. Price stalls under the same level several times, pushes above it, then drops back to touch it from above before carrying on. That touch is the retest, where the old ceiling is tried as a floor. A break that falls straight back under it is a false breakout.
An equity curve and its drawdownAn account balance rising over a year, falling from a peak to a trough, then climbing back to the old peak.ACCOUNT EQUITY$20k$12k$8k024681012TIME (MONTHS)PEAK $16,000TROUGH $12,000DRAWDOWN−25%RECOVERY
Equity curve and drawdown. An account balance plotted month by month. The fall from the $16,000 peak to the $12,000 trough is a 25% drawdown, and the shaded area lasts until the balance climbs back to the old peak.