Trends are one of the most common and basic things that traders will learn about when entertaining the idea of getting involved in financial trading. In this Wiki we will explore the Uptrend, the Downtrend, the Sideways Trend and combine these three trends with the basic cycle that we just looked at.
Understanding the basic concepts of trends is the main focus of this part of this Wiki.
Understanding how to properly define a trend is an essential element for successful and profitable trading. Without a deep understanding of trends and how to define them, traders may find themselves on the wrong side of the market. We estimate that being on the wrong side of the market, or trading against the trend, is possibly the cause of about 60-70% of all losing trades. We will discuss the different types of trends and how they can be useful in your trading and investing to help keep you trading on the right side of the professional market.
There are only three things that any financial instrument can do:
- Go up
- Go down
- Go sideways
In reality, there are only two types of trends which are up and down. What is referred to as a sideways trend is nothing more than a temporary pause between the two dominant trends, the uptrend and the downtrend trends.
Keep in mind that we are going to focus on what we call "simple crayon and finger paint drawings" in the beginning as we are fine-tuning our minds to grasp these concepts.
Figure 3.1: The Uptrend.
The uptrend is defined by higher highs followed by higher lows (see figure 3.2). The uptrend is also known as stage 2 in the basic cycle (see previous section in this Wiki for information on stages).
Figure 3.2: The Uptrend with higher highs and higher lows.
Once the criteria of an uptrend are met by having higher highs followed by higher lows, traders should be focusing on buying pullbacks and breakouts as long as there is a viable price pattern or trade setup. In an uptrend, the momentum is on the upside and the flow of money is into the market.
If you use moving averages they can help to define an uptrend by a rising moving average (MA). Using two moving averages, a long and short period moving average, can provide some insights into an uptrend by having the shorter period MA above the longer period MA and rising. Moving averages are a more simple and more visual way to define the trend.
An example would be if you were using a 20 and 200 period moving averages. The 20 period in this case should be above the 200 and rising to confirm that the market is moving higher and in a potential uptrend.
Figure 3.3: The Downtrend.
The downtrend is defined by lower highs followed by lower lows (see figure 3.4). This is also known as stage 4 in the basic cycle.
Figure 3.4: The downtrend with lower highs and lower lows.
Once the criteria for a downtrend have been met, by having lower highs followed by lower lows, the trader should be focusing on selling short all rallies as long as there is a viable price pattern or trade setup. In a downtrend the momentum is on the downside and the flow of money is out of the market.
If you use moving averages they can help define a downtrend by a declining moving average. Using two moving averages, a long and short period moving average can help define the downtrend by having the shorter period MA below the longer period MA and declining.
An example would be if you were using a 20 and 200 period moving averages. The 20 period in this case should be below the 200 and declining to confirm that the market is moving lower and in a potential downtrend.
The Sideways Trend
Figure 3.5: The Sideways Trend.
The sideways trend is defined by relatively equal highs and lows (see figure 3.6). This can form areas of major support and major resistance (more on support and resistance later in this Wiki). The sideways trend is also known as stage 1 and stage 3 in the Basic Cycle.
Figure 3.6: The Sideways Trend with equal highs and equal lows.
The objective of the trader in a sideways trend is to buy the dips and sell short the rallies. However, traders should keep in mind that all sideways trends will eventually breakout or breakdown to stage 2 or stage 4 trends.
Wide sideways trends with few overlapping candles create nice tradable price voids between supply and demand or support and resistance. The best sideways trends are the ones that are more predictable in how they move between areas of supply and demand.
Narrow ranges are often difficult to trade. If the candlestick bodies are side by side or overlapping they lose their predictability and the reliability of trading strategies drops in this kind of market environment. In narrow ranges, traders would be better off waiting for a breakout or breakdown to occur for a trading opportunity.
Sideways trends can be time corrections (a base or holding pattern) in an ongoing uptrend or downtrend. There are many times in a trending market that price will decide to stall and form a base moving sideways over time instead of correcting in the opposite direction of the trend (see figure 3.7).
Wide, whippy or uncertain sideways trends are less predictable (price may be in stage 3). Supply and demand areas remain constant in the area of the highs and lows but overlapping and sloppy candles make it difficult to identify a tradable price area.
Figure 3.7: Sideways time correction in ongoing trends.
Combining the Basic Cycle and the 3 Trends
There is only one basic movement a stock or other market can make and that is the Basic Cycle. The basic cycle is comprised of 4 stages; accumulation, rally, distribution and decline. The 4 stages are made up of 3 trends; up, down and sideways. This is the cycle that repeats itself over and over across any market. It’s driven entirely by emotion.
Figure 3.8 combines the Basic Cycle and its 4 stages with the 3 trends. This is how the market moves between areas of supply and demand from a very simple "crayon and finger paint" method of analysis. The key is to make your approach as simple as possible at the beginning when you are new to trading. Put a great foundation in place and build on it from there. This is the foundation for intelligent trend analysis. It really doesn't have to be any more difficult than this.
Study figure 3.8 until you understand the powerful messages held within it. We will expand more on it throughout this Wiki but please make sure you fully understand how powerful this graph is before moving on to more advanced concepts.
Figure 3.8: The Basic Cycle and its 4 stages with the 3 trends.
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