You must have heard the term share market trends or stock market trend quite often. What exactly are these trends and how to identify trends in the stock market? Remember, share market trends have several applications. They tell you the underlying story of the stock and also tell you whether the trend is continuing or reversing. These are useful inputs in trading. Let us look at how to identify trends in the stock market.
How do you recognise trends?
Let us quickly look at how to identify broad share market trends and more focused stock level trends. But, firstly, what does the trend mean and why is the understanding of trend so important. We will see later how a sound knowledge of basic trends of the market can improve the odds of success in trading. But, more of that later. Let us first understand the trend.
A trend in Technical Analysis is the underlying direction of the market and can be: uptrend, downtrend, or sideways trend. But let us understand why this trend is so important? In charting, the common phrase is that trend is your friend. A good trader must always trade in the direction of the Trend to maximize the probability of success.
The trendline shows the underlying trend of a price movement and gives an idea of whether the trend is up or down. It is like plotting a trendline to your chart in excel. It gives you an idea of whether the underlying trend is up or down. Trendline just confirms that the trend exists and is a better strategy than being intuitive as it is vulnerable to getting caught in a false trend analysis. The use of a trendline can overcome these challenges and offer a more scientific approach to identifying an underlying trend.
How do you define a trend?
In a nutshell, a trend is a general direction that a certain financial market, a representative index, or an underlying stock is taking. Trend analysis is that part of technical analysis that explains trends and helps traders to define the direction. You essentially identify and decipher a trend by connecting a series of highs or lows. This will give you an idea of whether it is an uptrend or sideways trend or a downtrend.
Let us look at an uptrend first. If you can connect a series of chart low-points sloping upward, you have an uptrend. An uptrend is always characterized by higher highs and higher lows. Now let us move to a downtrend. If you can connect a series of chart high points sloping downward, you have a downtrend. A downtrend is always characterized by lower tops and lower bottoms. A sideways trend does not define any direction but it can either be flat with volatility or flat without volatility.
Great, but how do you use a trend line?
That is the real million-dollar question. You check for the breakout of the trendline, which signifies a trend reversal. For example, if the uptrend line is broken and the stock closes below the uptrend line, you can say that the previous uptrend has ended. Similarly, when the downtrend line is broken and the stock closes below the downtrend line, it generates a buy signal since it signals that the previous downtrend has been broken. However, all these trend breakouts must be ratified with volumes, news flows, and chart patterns before taking any decision on trading.
There are two more important trading applications of a trend line
A very popular approach in an uptrend is to wait for the price to make a higher low and touches the lower trendline for a buy signal. Traders trading the range are buying when price touches support and selling when it touches resistance.
Remember, that a trendline can also help extrapolate the future price trajectory, and act as a warning system of when a trend could reverse. By looking at both longer-term and shorter-term trends, you can extrapolate future price movements.
Different types of market trends?
There are 3 classifications of trends that are captured by the trend lines.
Uptrend versus downtrend explains the direction of the price movement amid all the noise. It is the underlying trend. It is done by connecting a series of highs and lows. If you can connect low points sloping up, you have an uptrend. Similarly, if you can connect a series of chart high points sloping down, you have a downtrend.
Volatile versus lackluster trends are both types of flat trends or what we call a directionless market. This helps you distinguish whether you must play for volatility or play against volatility. Accordingly, you can decide whether you must opt for a long strangle or a short strangle, for example.
Short-term versus long-term trends are underlying trends in terms of time frames. For example, within a long-term trend lasting for 3-5 years, there can be a series of short-term downtrends. Many of the delivery investors also use the longer-term trend analysis to ratify their delivery positions.
Advantages of identifying trends?
There are 3 important advantages of identifying trends in technical analysis.
It helps you to immediately and decisively spot the overarching trends in any timeframe and trade accordingly.
Trend identification gives you a strong story on whether and how the trend reversals can be used for short-term gains.
Understanding the underlying trend of the market helps you to plot the supports and resistance levels with greater clarity and precision, in an actionable way.
Risks involved in intraday trading
Intraday trading carries distinct risks like a short time frame, too much leverage, illiquidity of select stocks in the market, etc.
