What is a market trend?
Market trend is the asset’s price direction over a given period. Market trends apply to all assets and markets such as foreign exchange, commodities, stocks and bonds, where prices and trading volumes fluctuate.
Yet, what is a market trend exactly and how can you make the trend your friend? Here we take a look at the market trend definition and how it can inform your trading strategy.
Market trend is defined as the asset’s price direction over a given period.
An asset or a market that experiences an overall price increase over a certain period is said to be in an uptrend or a bull market.
When an asset's price moves into a series of lower highs and lower lows, it’s said to be in a downtrend or bear market.
Market trends help traders and investors in identifying trading opportunities.
What is a market trend?
Market trend is the direction of the asset’s price over time. In technical analysis, when prices experience a series of higher highs and higher lows, they are said to be in an uptrend, which is often referred to as the bull market. In contrast, prices are said to be in a downtrend when they suffer through consistent lower highs and lower lows, known as the bear market.
Market trends help traders in identifying potential shifts in the market that they can speculate on.
How does a market trend work?
To understand what market trend mean, it’s important to note what factors may shape one.
Using fiscal and monetary policy, governments can slow or accelerate the growth of market trends. For example, adjusting a central bank’s interest rate could affect a country's economic growth, having a direct impact on cyclical and defensive sectors.
Market trends can be shaped by the sentiment among market participants. When traders and investors have faith in the direction of a country's economy or a company's business outlook, their optimistic attitude can shape a bullish trend. On the contrary, a negative market sentiment among traders can push the asset’s price lower.
Supply and demand
The asset price tends to fluctuate following shifts in dynamics between supply and demand. This is especially relevant for commodities. For example, when the economy is booming, demand for crude oil rises, oil prices tend to rise. Wars and mining disruptions restrict supply, therefore too boosting the prices.
Corporate and economics news
Upbeat results in company quarterly reports or positive economic readings that beat expectations can all contribute to an uptrend. On the contrary, negative news could push prices lower, creating a downtrend.
Different types of market trend explained
There are different types of market trends depending on the length and the drivers behind the trend.
Secular trends can last from years to decades. They are often shaped by structural changes in the economy and demographics. For example, the current shift towards sustainable energy is considered a secular trend.
Primary trends can last from multiple months to multiple years. They are driven by changes in the business cycle as well as political and economic events. For example, the US Federal Reserve’s (Fed) monetary tightening cycle can be considered a primary trend.
Secondary trends can last from several weeks to several months and are defined by changes in investor sentiment as well as technical factors.
These trends can last from days to weeks. They are typically driven by the changes in supply versus demand dynamics and market volatility.
Minor trends can last a few days or less. These short-term trends are typically shaped by current news and changes in trading volumes.
How to identify a market trend
Both technical and fundamental analysis can be used to identify market trends.
A trendline is a straight line which connects a series of price points – highs and lows – and extends into the future.
An uptrend trendline connecting a series of higher lows creates a support level for future price movements. On the contrary, a downtrend trendline connecting a series of lower highs indicates the support level.
Relative Strength Index (RSI)
An RSI determines whether a stock is overbought or oversold by measuring the speed and magnitude of price changes.
An RSI reading of 30 or below indicates that the market is oversold while a reading of 70 or above shows the overbought condition. Both of these readings signal that a trend reversal is likely.
Moving averages (MA)
Meanwhile, moving averages are used to distinguish clear price action from the market clamour. There are two moving averages: simple moving average (SMA) and exponential moving average (EMA).
SMA calculates the mean of a set of prices over a certain period of time in the past. For example, SMA calculates the mean of prices in the past 20-days, 50-days, 100-days and so on. Meanwhile, EMA is a weighted average that emphasizes a stock's price in recent days, making it a more responsive indicator to new information.
Moving averages are also used to determine support and resistance levels of an asset’s price, and the overall price trend.
Investors can also use fundamental analysis to identify a market trend by looking at changes in business or economic metrics, such as revenue and earnings growth.
When a company records positive earnings growth for several consecutive quarters, it represents a positive market trend example. On the other hand, when a company’s earnings fall consistently over a certain period, it shows a negative trend.
Trading with a market trend
The next question is how does a market trend work in trading?
When a market or an asset's price rises, traders typically assume that it will keep rising until there are obvious indications that the price could drop. When the price falls below a trendline or technical indicators turn bearish, a price rally could be running out of steam.
Traders using a trend-following strategy would focus on buying while the price is rising, and selling when the indicators are signalling a trend reversal, in other words, when the price starts to fall.
A market trend can be a useful tool to inform a trading strategy. Remember, your final decision to trade should be based on your risk tolerance, market expertise, portfolio size and composition. Always conduct your own research before trading, and never trade money you cannot afford to lose.
What factors influence a market trend?
The factors that can influence a market trend include but are not limited to: government policy, investor sentiment, supply and demand dynamics and corporate and economic news.
How can market trends help in trading?
Market trends are an essential tool in trend following strategy: where traders open positions in line with the direction of a trend.
How can investors identify a market trend?
Technical analysis tools such as the trendline, the Relative Strength Index (RSI) and moving averages are popular to identify market trends. Traders can also use fundamental analysis, such as earnings growth or long-term supply-demand dynamics, to help in evaluating a trend.
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