Eat, Sleep, Trade
Technical Analysis Through Charts
Identifying Market Trend, Trend Reversal,
& Trend Line Drawing
There are two different types of Trends. First we have an Uptrend, This is produced when a stock continually puts in higher highs as well as higher lows. The second Trend which is just the opposite and is known as a Downtrend. Downtrends are formed when a stocks price puts in lower highs and lower lows.
Trends can be identified not only through a specified ticker symbol but also when looking at an index as a whole. A stock market index is a measurement of the value of a large section of the stock market. Examples are S&P 500 INX or the Dow Jones Industrial DJIA. When an index is trending up it shows that the stocks in that index are performing well.
1.Trend lines are not perfect. Use them as a guide.
2.A break of a trend line does not guarantee a change of trend.
3. Longer term trends are more accurate.
4. The more times a trend line is tested, the stronger it becomes.
Up trends are formed when a stock continually puts in higher highs combined with higher lows. Ideally you would want the stock your trading long to be in an uptrend. You don't want to be trading against the trend as this would put you at a disadvantage.
Down trends are formed when a stock continually puts in lower highs and lower lows. Ideally you would want the stock your trading short to be in a down trend. You don't want to be trading against the trend and shorting stocks that are putting in higher lows can lave you in a bad situation.
The entire purpose of using trends and trend lines is to help us identify when a trend is going to change. A change in trend is known as a trend reversal, these reversals can be great spots to get in and out of trades. There are a couple rules to confirming a trend reversal, lets take a look.
Down Trend Reversal
Drawing Trend Lines:
Drawing trend lines is pretty simple and there is no reason to over complicate it. If your attempting to draw an up trend it is as simple as connecting at least two consecutive higher lows. For a down trend it is just the opposite, simply connect two consecutive lower highs. Having trend lines drawn on your charts will help to see the current trend and insure your trading on the right side of that trend. Like everything else with technical analysis nothing is guaranteed when it comes to trends. A trend can change very rapidly and as often as it wants. The more times a trend line is tested and holds, the more stronger that trend becomes. It is also important to understand that just because a trend line is broken, it does not constitute that the trend is broken and that a trend reversal will occur. Trend reversals need to be verified with confirmation signals that we will take a look into next.
Trends are extremely helpful in trading, understanding them will keep you trading on the right side of the trend and increasing your chances of success. Trend lines are a great way to visually identify trends, but as everything with technical analysis you cant just base your buying and selling off trend line touches. Always remember trend lines aren't perfect and a broken trend line will not guarantee trend reversal.
Return to The Basics of Swing Trading.
Our previous lesson was Position Size & Risk Management if you missed it.
Take a look at how we draw Support & Resistance on a stock chart.