Trendis one of the most important concepts in technical analysis. In a very simple language, a trend shows in which direction stock price or market is heading. A trend represents a consistent change in prices (i.e., a change in investor expectations).
There is a very famous saying in reference to the trend in stock market :
“Trend is King”
Take a look at the chart below:
When we look at the above figure, we see that the stock price has held upward slope which means the trend is towards upside. However, most of the times it’s not always this easy to see a trend.
In below figure we can see that here are lots of ups and downs in this chart, and therefore there is no clear visibility of trend.
But in reality, it is not an easy task to identify Trend as prices of the stock always fluctuates that is they do not move in a single straight line in only one direction, but rather they move in a zigzag manner forming continuous series of lows and highs. When we talk about the Trend in technical analysis, what we are actually doing is studying and analysing these series of lows and highs to identify the Trend of the stock. For example, when a stock is an uptrend then the chart pattern of that stock will contain higher highs (tops) and lower lows (bottoms) whereas in a downtrend the pattern will be of lower highs and lower bottoms.
Peak : It is the high price on the charts in a pattern developed by the price action of stocks.
Trough : It is the low price on the charts in a pattern developed by the price action of stocks.
Below figure shows some peaks and troughs in a chart :
Types of Trend
There are three types of trend:
Uptrend : When the movement of the stock contains higher tops (highs) and higher bottoms (lows) that is when each successive tops (high) and bottom (low) is higher than the previous ones, then the stock is said to be in Uptrend. In below figure we can see how the pattern looks like when a stock is in uptrend. In below figure, we can see that point 2 in the chart is the first high, which is identified after the price falls from this point. Point 3 is the low that is determined as the price falls from the high of point 2. For this stock to remain in an uptrend, the next low should not be lower than previous lows otherwise it will be said that a reversal has taken place.
Downtrend : When the movement of the stock contains lower tops (highs) and llower bottoms (lows) that is when each successive tops (high) and bottom (low) is lower than the previous ones, then the stock is said to be in Downtrend. In below figure we can see how the pattern looks like when a stock is in downtrend. In below figure, we can see that point 2 in the chart is the first low, which is identified after the price rises from this point. Point 3 is the high that is determined as the price rises from the low of point 2. For this stock to remain in an downtrend, the next high should not be higher than previous highs otherwise it will be said that a reversal has taken place.
Sideways/Horizontal Trends : When the stock moves sideways with no clear movement either up or down then this movement of stock is called sideways trend or horizontal trend. But in reality, we don’t consider sideways trend as a trend because they don’t give clear indication and lack visibility while predicting in which direction the market or the price of the stock is heading.
Along with the three trend directions, trend can be further classified into :
- a) Long-term trend – a trend is said to be long-term trend if it lasts more than a year.
- b) Intermediate trend – a trend is said to be intermediate trend if it lasts between one and three months.
- c) Short-term trend – a trend is said to be long-term trend if it lasts less than a month.
Note :When we look at a long-term trend we can find that it is made up of several intermediate trends, which are often seen to be moving against the direction of the major trend. If the major trend is in uptrend and in between there is a downward correction in stock price movement which is followed by the continuation of the uptrend, then this short term correction is known as an intermediate trend. The short-term trends are found in both major and intermediate trends. Please have a look at above figure and you will get an idea of how these three trend lengths looks like.
When we try to analyse trends, we should make sure that the chart is constructed in such a way which can give us a good overall picture of what type of trend we want to analyse. In order to identify long-term trends, we can use weekly charts or daily charts with a long time period such as time period of five-year which is mostly used by all technical analysts which ultimately gives them a better idea of the long-term trend.
We can also use daily data charts to analyse both intermediate and short-term trends. One thing to note here is that the importance of the trend is directly proportional to the time length of the trend which means the longer is the trend the more important it becomes that is a one-month trend will not be as significant as a five-year trend
A trendline is a very basic technique used in charts to identify the trend of the stock along with other useful information like support and resistances. To draw a trendline one can just draw a simple line from the lows or highs according to the movement of the stock. Figure below illustrates how to draw a trendline. This trendline is helpful to find all the support and resistance points of the stock from where reversal can take place. As you can see in below figure, just pay attention to how the price of the stock takes reversal every time it hit the support points. This type of trendline helps traders to predict the point at which a stock’s price will gain support and begin moving upwards again. Similarly, to draw a trendline that shows downtrend, one should make a simple line which touch the highs of the stock price in a downward trend. This trendline gives the resistance levels that a stock faces every time the price moves from a low to a high.
Note : We will learn more about Support & Resistance in next chapter.
A channel, is just a group of two parallel trendlines that show both support and resistance points of a stock. The lower trendline touch the series of lows made by the stock whereas the upper trendline touch the series of highs. Below figure clearly illustrates how the channel is formed. A channel helps in identifying the direction of trend along with support and resistance points. A trader can look at these support and resistance points to either take a long trade if a stock price is near to support price and book profits or take a short trade when stock price is near its resistance.
As we can see in the figure above, two trendlines have been drawn touching the lows and highs made by the stock. The price of the stock has taken reversal whenever it has touched this channel line and has been range-bound for months.
Importance of Trend
For a stock investor and trader it is very important to understand and identify trends so that you can trade with rather than against them. There are two important sayings in technical analysis regarding trend :
“Trend is your Friend”
“Don’t buck the Trend”
In next chapter we will learn How to identify Support and Resistance of a Stock.