The major rule of technical analysis states that “prices move in trends”. Even though stock price movements may look random, this fundamental assumption means that prices tend to follow short, medium and long-term trends.
The question is: how do you spot a trend? Let’s try to find it out.
What are market trends?
We can define three major price trends: an uptrend, a downtrend and trading what is known as sideways. When the market is indecisive, we may expect it to trade sideways. When the market is driven by some positive news, we may see an uptrend. And vice versa, in case of negative news coming to the market, the price turns back and begins a downtrend.
If you’re a lucky trend trader (or smart enough) to spot the emerging trend right at its origin, you will be able to jump into the up- or downtrend and try to place a profitable trade.
Why do prices move in trends?
Despite all the regulators’ efforts, price-sensitive information comes to the market rather slowly. First, it becomes known to insiders, then it is spread to their close circle, and then further on, it reaches financial experts, analysts and big investors. In the end, it comes to ordinary traders.
Financial and political news often make the price go up or down. However, the spread of the information takes time. The market’s reaction can be also time-consuming. It paves the way for the trend to mature.
Real people stand behind price movements.
How to spot trends
The ability to identify a market trend is crucial when it comes to trading. Spotting the trend at the very beginning can be rewarding for trend traders.
Here’s a short video guide on a trend trading strategy that may help you identify and use the trend in your favour.
There are some noteworthy indications that may help you understand the process of trend building.
A recent uptrend is not a cause to be bullish
Indeed, a steadily rising chart over the past several months looks promising. However, don’t forget that it may be just a rebound from a sharp drop. That’s why in spite of a positively looking image, we read the warnings about the bear market’s “trap” — or, a good-looking rise during an overall bearish market trend.
Examine the all-time highs
The major thing in spotting the price trend is the evaluation of the market’s all-time highs. Stocks trading in all-time lows or highs areas are ultra-sensitive to changes. A wide range of stocks are rising close to or above their record highs. Therefore, it may be a good hint to pay attention to stocks at their all-time highs as a source of speculative returns and a market trend confirmation.
Trend is your friend: history tends to repeat itself
Probably the best way to spot an emerging trend is to go through the market’s historical price pattern and compare it with a current situation.
People’s reactions almost never change, so you may predict that today, traders will react in a similar way they did in the past when faced with the similar market events.
Though technical trend indicators show us the current market’s performance with no goal to predict upcoming market trends, they are the perfect tools for us to understand the market’s performance and analyse its price movement.
Though the best brokers provide a wide range of technical indicators (Capital.com offers 75), the 4 most popular indicators include:
a. Moving averages are widely-used trend indicators that help to observe the market’s price fluctuations according to historical data for a predetermined timeframe. It allows to depict the general trend’s flow.
Moving averages provide trend traders with a clear vision whether to go long or short on a particular stock.
b. Bollinger Band trend indicators measure the volatility of the market’s price fluctuations. Bollinger Bands consist of three lines – the lower band, the middle band and the higher band. The lower and upper bands shows 2 standard deviations away from the mean average.
When markets become volatile, the distance between the bands becomes wider – and vice versa in case of low volatility.
c. The MACD (Moving Average Convergence Divergence) indicator allows us to conduct a comparative analysis of two moving averages for different timeframes. Through MACD, a trend trader can assess the price swings for two different periods. The comparison is performed according to the 3 parameters, including convergence, divergence and dramatic rise.
d. OBV (On Balance Volume) is a trend indicator that measures the market’s volume flow to determine the trend direction. Volume itself is a valuable indicator, and the OBV compiles this information into a one-line indicator. Price and volume are directly proportional. A rising price is indicated by a rising OBV and a falling price is indicated by a falling OBV.
If the OBV increases during the increasing price trend, it signals that the price trend is sustainable. When the OBV shows a decline, and the price trend is still increasing, it can signal a price trend reversal.
The good thing is that trend traders can use a combination of different indicators to create their own trend trading strategies. Learn more about the available technical analysis tools and adapt them to your personal trading experience.