As we have learnt that one of the basic tenet of Technical Analysis is “Price Moves in Trends”. Here in this section we will understand what is trend, how to identify trend and how to trade with trend.
What is Trend in stock Analysis? In general terms, the trend is determining some development taking place in consistent way and getting stronger with time and is identifiable. It is same in stock analysis, where movement of stocks is analyzed and tried to determine if it is moving in consistently in one direction and move getting stronger and is clearly visible. Trend could be continuous upward movement of stocks or may be continuous downward movement of stocks or in some case movement in a range. Whichever the case is, once identified, a profitable trade can take place.
As per Dow Theory, once stock is in trend it will continue to move in trend, until an external factor interrupts it. Some of these factors could be company result, or some exciting development in company, major local/global, and economic/political factors. Those from science background can relate trending stock with Newton’s second law of motion.
Why stocks moves in trends? As we have seen in market cycle, information about stock does not reach to masses at the same time. It starts with well-informed traders, then to little less informed traders and then to the masses. With each participating at different stages, money is continuously moves in or out of the stock and a unidirectional movement of stock price is seen.
Other factors could be limited capital/ liquidity with informed trader which restricts huge amount of capital at one shot. Or traders limiting their risk, and pumping money gradually to see overall market reaction.
One of the important things to note is stocks does not moves in a purely one direction, even in an extremely strong trend, there are multiple pullbacks. These are due to profit taking, honoring intermediate support and resistance and capital availability. Trend interval can be as small as few minutes to few years.
Also since technical analyst believes that prices moves in trends, they also participate in them making it to move further sometimes even beyond logical trending period.
Types of trend
Uptrend: In this case stocks continuously moves in upper directions and traders profits by taking a long position. More details of uptrend with examples are explained in uptrend section.
Down Trend: Similar to uptrend, the stock continuous make directional move but in case of downtrend the price falls continuously. Traders make profit by taking short position. More details of downtrend with example is explained in uptrend section.
Sideways: In case of sideways market, stock price tends to move in within a price band. Traders take advantage by taking multiple long and short position within the range.
Non-Trending: Though similar to sideways market where stock does not make unidirectional move, in case of non-trending, no clear support or resistance is seen.
Trading with Trend Irrespective of the direction of the trend, technical analyst can make a profitable trade. Among the four, uptrend and downtrend gives maximum profit in a single trade, while sideways market trend to give multiple opportunity but of small profit. In case of on non-trending stock or volatile market, its better advised to keep away from any trade.
Trends are traders best friend provided you find right one.
Example of Complex Trend Formed By NTPC Ltd
A complex Trend is a trend in which short trends are formed within a Major Trend.