What is a market trend?
Looking for a market trend definition? It’s the perceived direction of price movements over a particular period. Market trends apply to all assets and all markets where there’s movement on prices or volumes bought and sold.
Trends can be long-term (“secular”), medium-term (“primary”) or short-term (“secondary”), and all trends can offer investors the opportunity to profit. We speak of uptrends when prices experience a succession of higher highs and higher lows, and it’s a downtrend if there are consistently lower highs and lower lows.
Where have you heard about market trends?
If you’re an investor, or simply interested in the economy, you’ll hear about market trends all the time. Trends are often discussed in relation to interest rates, though they can also apply to shares of a particular company or to the stock market in general. When analysts talk about the current mood in the stock market, for example, you’ll often hear them using the terms “bull market" and "bear market". Simply put, these are terms describing upward and downward market trends. In a bull market shares are on an upward trend, while in a bear market they are heading downwards.
What you need to know about market trends...
Four major factors are generally thought to shape market trends:
- Governments, through fiscal and monetary policy, can slow down or speed up growth
- The flow of funds between countries – both inward and outward – can impact the strength of a country's economy and its currency
- Speculation can create an expectation of future price rates and trend direction
- Supply and demand for products, currencies and other investments creates movement in prices, both up and down depending on who wants what, and whether it’s available
Market trends are analysed by comparing historical price movements against a current price. And trend lines are a key tool in technical analysis for trend identification and confirmation. In basic terms, a trend line is a straight line connecting two or more price points and extending into the future. Trend lines can go up or down:
- An uptrend line has a positive slope and is formed by connecting two or more low points. The second low must be higher than the first for such trend lines to have a positive slope. And at least three points must be connected before the line is considered a valid trend line. Uptrend lines indicate that net demand is increasing even as the price rises. A rising price combined with increasing demand is very bullish, and shows strong determination on the part of buyers. So long as prices stay above the trend line, the uptrend is considered solid and intact. A break below the uptrend line suggests that net demand has weakened and a change in trend could be about to happen.
- A downtrend line has a negative slope and is formed by connecting two or more high points. The second high must be lower than the first for the line to have a negative slope. At least three points must be connected before the line is considered a valid trend line. Downtrend lines indicate that net supply is increasing even as the price falls. A declining price combined with increasing supply is very bearish, and shows the strong resolve of sellers. So long as prices stay beneath the downtrend line, the downtrend is solid and intact. A break above the downtrend line suggests that net supply is decreasing and a change of trend could be on the cards.
A trend analysis can help traders to try and predict what will happen with a stock in the future. Trend analysis takes into account historical data points for a stock and – bearing in mind other factors like general changes in the sector, market conditions and competition for similar stocks – it helps traders to forecast short, intermediate and long-term possibilities for the stock. By conducting a trend analysis, a trader may be able to match purchases and sales of particular stocks, maximizing the potential for profits. But, it’s also important to look at historical data in the context of conditions for the underlying company to see if there are factors that could affect a stock's value regardless of market conditions or past performance. So, a trader should also examine the financial conditions of the company, understand the market and technologies, and anticipate competitive pressures on the company within its sector.
Trend traders are investors who look for trends in the movement of an asset, and build a strategy around that analysis. For them, ‘the trend is a friend’, and it’s considered unwise to work against it. Trend trading strategies include employing a long position when stock is heading upwards, and a short position when stock is heading down.
Trend trading assumes that the current direction of the stock will continue into the future. It can be used by short, intermediate or long-term traders. Regardless of their chosen time frame, trend traders remain in their position until the trend has reversed. But surprises happen, and investors can make losses if things go against them unexpectedly.
Savvy investors have a range of technical analysis tools at their disposal, including Relative Strength Index – or RSI – analysis. This gauge measures the speed and size of stock price changes, and allows investors to see if a stock is being overbought or oversold. Another technical analysis tool is the Moving Average, which can help identify clear price action beyond the market noise. Simple Moving Averages (SMA) and Exponential Moving Averages (EMA) are the most frequently used moving averages.
Of course, investors also have to bear in mind the business cycle. This is the fluctuation in economic activity that an economy sees over a period – essentially, the downward and upward movement of gross domestic product around its long-term growth trend. A business cycle is basically defined in terms of periods of expansion or recession.
During expansions, the economy grows in real terms (excluding inflation), with increases in indicators like employment, industrial production and personal incomes. An example of an expansion earlier this century was in the US economy from 2001-07, when house price growth fuelled an expansion of the construction and financial services sectors.
During recessions, the economy contracts, with all the key economic indicators falling. The most notable recent recession was the Great Recession of 2007-09, when private consumption in the US and much of Europe fell for the first time in nearly two decades.
Expansion is measured from the trough of the previous business cycle to the peak of the current cycle, while recession is measured from the peak to the trough. In the United States, the National Bureau of Economic Research determines the official dates for business cycles.
The Dow theory on stock price movement is one form of technical analysis that can help illuminate market trends. The theory was derived from Wall Street Journal editorials written by Charles H. Dow, founder and first editor of The Wall Street Journal and co-founder of Dow Jones and Company.
According to Dow theory, major market trends feature three phases: an accumulation phase; a public participation (or absorption) phase; and a distribution phase. The accumulation phase is a period when investors ‘in the know’ buy or sell stock against the general market opinion. In this phase, the stock price doesn’t change much because these investors are in a minority. But, the market eventually catches up with these perceptive investors, and a rapid price change takes place when trend followers and other technically oriented investors participate. This phase continues until massive speculation occurs. And at that point, astute investors start to distribute their holdings to the market – which is the final phase of Dow theory.
Finally, this might sound obvious, but it’s important all the same: a trend can only be definitively determined with the benefit of hindsight, as future prices can’t be known with any certainty. Trend analysis is an investment aid, but it can’t always predict what hasn’t happened yet. For example, the long-term oil price trend might be downward – until an unforeseen international crisis suddenly triggers a massive oil price spike overnight. So, it’s always wise to bear future unknowns in mind.
Find out more about market trends…
Our glossary has lots more information about the workings of the stock market and, for example, about what it means to take a short position or a long position.