Friday, May 14, 2021

What is Trend & Why is it Important in Trading

Learn from the above video and do not miss the post. This post will help you learn in depth and revise what you learn in the video chapter.

To trade in the market you need to develop an idea or a view on markets.

In this chapter, we will learn about market trends which is an important parameter to take a trader of have a view in the market.

What you will know:

  • What is trend?
  • What is the importance of trend?
  • How to identify different types of trend?
  • Beliefs in technical analysis.

What is a trend in Trading And Investing

From a technical analyst’s perspective, “a trend is a directional movement of prices that remains in effect long enough to be identified & still be profitable”.

A trend can be upward, downward, or sideways.

When the prices make higher highs & higher lows which are shown in Fig. 1.1 (a) we call it an UPTREND.

On the other hand, when prices make lower lows & lower highs as shown in Fig.1.1 (b) we call it as DOWNTREND.

Also, when prices move in a rangebound area without any significant Up-move or Down-move as shown in Fig 1.1 (c) a SIDEWAYS or FLAT TREND is established.

But defining a trend in the real-world market is not that easy because the prices do not move so smoothly & follow the continuous line, rather they move in a very random & interrupt the lines in real-world markets.

There may be some movement in the opposite direction within a trend which makes it difficult to identify the real trend at a particular time.

Also, there are trends of different lengths. Shorter time frame trends are part of the longer one.

Fig 1.1 (a) {UPTREND}
Fig 1.1 (b) {DOWNTREND}

Fig 1.1 (c) {SIDEWAYS}

Importance of Trend in Trading and Investing

A trend is very important & a basic element of technical analysis.

If a trend is not identified until it gets over, it is very difficult to make money from it. A trend must be recognized as early as possible & it should be long enough to make some profit within it.

If perfectly, identified, a trend will help us to know the direction of the price to where they are heading. If we know the trend of the price, we are on the first step of making money in the stock market.

There is a well known saying that ”Trend is friend – always follow the trend” which is very correct. But we should be more precise over it & say it like – “Trend is friend – always follow the RIGHT trend “.

Just like we have many friends in our life, there may be many of the trends available in the market. Which one to follow & which to leave is the key part. Therefore to identify the right trend is the most important part of the technical analysis.

How to Identify Trend?

To Identify the trend there are many methods.

Some people use maths, some people use geometry, some people use different indicators based on mathematical calculations

Regression analysis is the technique which can be used to determine the trend by the method of best fit line among the different set of data.

Using a different period of moving averages like 20 periods, 50 periods, etc. the trend can be determined.

Identifying the pressure points at tops & bottoms & drawing the lines connecting these pressure points gives us what we call Trend Lines (most widely used) to determine the trend.

Beliefs in Market Analysis:

There is some section of analysts or traders who follow a very basic theory based on supply & demand.

When demand increases, the price goes up, and when demand decreases, the price goes down.

Demand will increase when buyers expect that the price will go up in the future & this expectation arises due to information which traders get somehow.

Some of the information is accurate, some are false, some are based on rumors. The expectation also arises due to human emotions like fear, greed, hope, etc.

Another section of analysts or traders thinks that price discounts every information. Whatever the price you see on the charts is discounted by all kinds of information. This concept was first used by CHARLES H. DOW (whom we know as the father of technical analysis) which we will be going to discuss further.

Some people believe history repeats itself. Whatever happened in the past likely to happen again & based on this, they determine the supply-demand & trade accordingly.

The human mind behaves in a similar way to what it behaved in the past in similar situations. Because of this similar behavior, the prices tend to form a pattern in the market & these patterns have predictable results.

Some of the analysts or traders believe that the patterns are fractal in nature. There are many types of players in the market having views of different time frames. Some people having a mindset of 2 months, some people come to the market with a view of 2 years & some of them come with the view of the long term of around 20 years.

Despite having different views, the pattern formation takes place in similar, shapes & characteristics. That means if you see a 5 mins candlestick chart and observe a pattern, you can see the similar kind of pattern formation on monthly charts.

Although these periods having very little or no impact on each other.

For example, a 5 min chart trader who is simply a day trader has no impact on the trader who is looking over a monthly chart who is having a long term perspective.

Last but not least EMOTIONS!

Some believe that emotions play a significant role in the market. The emotion of one person affects another one & it transmits to the next one. If someone has bought a stock, he/she will recommend others to buy that stock.

Those who are having the information that somebody bought this stock & the prices are moving up, they will rush & start buying for themselves & the process go on.

But this could be very dangerous.

Emotions can be the biggest enemy for a trader or investor in the market. Overvaluation of a stock just because of buying due to emotions can cause a panic situation when there is a sharp decline in the prices.

I Hope you understood this chapter. If you have any query, do comment below and I’ll reply.
Keep Learning!

POST AUTHOR

Manish Bhardwaj
Manish Bhardwaj is a full-time trader investor, an analyst for over six years and now, he is also a trading content creator. On a random day, Manish and Sharat were discussing their plans of helping people and both understood that they have almost the same vision. So, they collaborated to take TradingSutra to the next level.

6 COMMENTS

  1. Sir
    In uptrend when 2nd higher trend when it breaks previous higher value how much it can move in upward can be calculated before it start to move down

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