What is a Trend?
A trend represents the overall direction of a market or an asset’s price over a specific period. Whether delineated by trendlines or price action, trends highlight when a price is making higher swing highs and higher swing lows indicative of an uptrend, or lower swing lows and lower swing highs pointing to a downtrend.
Many traders prefer to trade in the same direction as the trend, capitalizing on its persistence, while contrarians seek reversals or trade against it. Trends are evident across all markets, be it stocks, bonds, or commodities, and similarly manifest in repeated data patterns, like monthly economic indicators rising or declining.
Key Takeaways
- A trend signifies the general direction of the price of a market, asset, or metric.
- Uptrends are indicated by rising data points, such as increasing swing highs and swing lows.
- Downtrends are marked by declining data points, such as decreasing swing highs and swing lows.
- Traders often ride the trend to profit from its continuation.
- Trend identification tools include price action, trendlines, and technical indicators, which also serve to warn of trends reversing.
How Trends Work
Traders identify trends using various forms of technical analysis, including trendlines, price action, and technical indicators. For instance, trendlines might illustrate the trend’s direction, while the relative strength index (RSI) shows its vigor at specific junctures.
An uptrend signifies an overall price increase, characterized by newer swing lows and highs outpacing the older ones. Conversely, when these structures break down, it’s possible an uptrend is weakening or transitioning into a downtrend.
Uptrending phases have traders focusing on buying opportunities, anticipating continued price escalation until indicators suggest otherwise—such as lower swing lows or highs and bearish technical indicators. In contrast, traders shift to selling or shorting during downtrends to minimize losses or gain from the price fall. Despite natural downtrend reversals, as prices drop, many traders dive in attracted by perceived bargains, potentially heralding another uptrend.
Trends play a significant part for fundamental analysts, focusing on business and economic metric changes. For instance, earnings per share (EPS) trends: rising EPS for multiple quarters symbolizes a positive trend, while declining EPS portrays a negative outlook.
No trend, where there’s muted upward or downward progress, is referred to as a range or trendless period.
Using Trendlines
Accurate trend identification often utilizes trendlines connecting highs (if downtrend) or lows (if uptrend). Uptrends involve linking a series of higher lows to illustrate a support level for predicting future movements. Downtrends attach a collection of lower highs to create resistance levels. These trendlines succinctly portray the trend direction.
Trendlines effectively chart overall direction, but they need periodic adjustments to stay relevant. For instance, even during robust uptrends, momentarily dropping below the trendline doesn’t negate the trend; it calls for redrawing. A concise trend determination need blended insights from other technical indicators along with trendlines as a descending leg drop alone may not spell sell signals until corroborative indicators turn bearish.
Example of a Trend and Trendline
Shown by the chart below is a sample ascending trendline partnered with high RSI readings, affirming a vigorous trend. Amidst price oscillations, the overarching direction inclines upwards.
The initial rising trend gradually loses momentum followed by selling pressure fortifications. RSI subsides below 70, succeeded by a pronounced downturn candle reaching the trendline, later confirmed by a mere trendline breach through price gapping below. Consider these indicators when exiting long positions or initializing short trades, signaling potential trend inversion.
Image by Sabrina Jiang© 2021
As prices drop and attract buyers veering towards lower costs, another trendline could map the downward price movement, signifying potential rebounds, valid near parts where marked V-shaped recoveries could rejuvenate positive trends.
Related Terms: price action, technical analysis, swing highs, swing lows, trendlines, uptrend, downtrend
References
- Fidelity. “Basic Concepts of Trend”.
- Fidelity. “Relative Strength Index (RSI)”.
