A trend is the overall direction of a market or an asset’s price. In technical analysis, trends are identified by trendlines or price action that highlight when the price is making higher swing highs and higher swing lows for an uptrend, or lower swing lows and lower swing highs for a downtrend.
Many traders opt to trade in the same direction as a trend, while contrarians seek to identify reversals or trade against the trend. Uptrends and downtrends occur in all markets, such as stocks, bonds, and futures. Trends also occur in data, such as when monthly economic data rises or falls from month to month.
3 directions of trend
- An uptrend is made up of ascending peaks and troughs. Higher highs and higher lows.
- A downtrend is made up of descending peaks and troughs. Lower highs and lower lows.
- A sideways trend (consolidation) is when prices move sideways in a horizontal range.
Primary: Long-term (i.e., 1 year or longer): The tide in Dow’s explanation
Secondary: Intermediate (i.e., 1 to 3 months): The waves
Minor: Short-term (i.e., less than 1 month): The ripples
Technical indicators are heuristic or pattern-based signals produced by the price, volume, and/or open interest of a security or contract used by traders who follow technical analysis.
By analyzing historical data, technical analysts use indicators to predict future price movements. Examples of common technical indicators include the Relative Strength Index (RSI), Money Flow Index (MFI), stochastics, moving average convergence divergence (MACD), and Bollinger Bands.
Technical analysis is a trading discipline employed to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume. Unlike fundamental analysts, who attempt to evaluate a security’s intrinsic value based on financial or economic data, technical analysts focus on patterns of price movements, trading signals, and various other analytical charting tools to evaluate a security’s strength or weakness.
Technical analysis can be used on any security with historical trading data. This includes stocks, futures, commodities, fixed-income, currencies, and other securities. In this tutorial, we’ll usually analyze stocks in our examples, but keep in mind that these concepts can be applied to any type of security. In fact, technical analysis is far more prevalent in commodities and forex markets, where traders focus on short-term price movements.
Supports and Resistances:
Every house has a ceiling and floor, which supports you from the bottom. Alternatively, you cannot go above the ceiling (assume there is no terrace). So, the ceiling restricts your movements. Similarly, Technical analysis theory believes that there is a glass ceiling (top) and a glass floor (bottom) in every stock chart. Stock prices move only between these two levels unless there are major breakouts.
When the ceiling is reached, a stock will not appreciate any further. If you are in possession of the stock, you should sell it immediately. This glass ceiling is called resistance. Similarly, there is also a minimum price level, below which the stock will not fall. This level is called resistance. Every time the stock falls to this low, it will bounce back. As a result, you want to buy at this price.
Successful investors are able to pick these technical indicators accurately. They buy a stock when it is close to its support and sell it when it is approaching its resistance. These supports and resistances are not constant over the long term and keep changing. Supports and resistances keep moving higher or lower.
Supports and resistances are created because investors act in packs. When they think a stock is good, they all scramble to buy it and when a stock is bad and should be sold, they sell it. This tendency is called herd mentality. Buying in bunches prevents prices from falling beyond a level. Similarly, selling in packs prevents the price from rising beyond the resistance. You should try to spot supports and resistances by looking at stock charts and finding points where prices have stagnated or reversed after rising/ falling for some time. You should look out for what happens when these price points are reached in the future.
Change in Polarity Principal:
So, what happens when supports and resistances are breached? Since investor activity is so high at these levels, a breach means that investors are not interested in buying and selling them anymore. This leads to prices moving violently. Once a support is breached, stock prices tend to enter a freefall zone. They form new supports. Similarly, when resistances are broken, prices tend to shoot up and form new resistances. According to the change in polarity principal, every time a support is breached it becomes a resistance. Likewise, every time a resistance is breached, it becomes a support for the future. You must watch out for prices when they are around a support or resistance zone and act upon any breach instantly.
You must also watch out for some other important chart patterns that reveal where the stock price will head next. These patterns are classified into reversal and continuation patterns. Reversal patterns indicate that a trend that was guiding the stock price till now has ended. Now, the stock will move in the reverse direction. So, if the stock was appreciating it will fall, and vice versa. Important reversal patterns include head and shoulders, inverse head and shoulders and, double tops and double bottoms.
Continuation patterns are a confirmation that the present trend will continue. You must keep holding on to your stocks if they are rising or, sell them at once if they are falling. Important continuation patterns include triangle pattern, rectangle pattern and flags and pennants. We will discuss these patterns in the section on chart patterns.
Technical indicators are used by traders to gain insight into the supply and demand of securities and market psychology. Together, these indicators form the basis of technical analysis. Metrics, such as trading volume, provide clues as to whether a price move will continue. In this way, indicators can be used to generate buy and sell signals. In this list, you’ll learn about seven technical indicators to add to your trading toolkit.
Tools of the Trade
The tools of the trade for day traders and technical analysts consist of charting tools that generate signals to buy or sell, or which indicate trends or patterns in the market. Broadly speaking, there are two basic types of technical indicators:
Overlays: Technical indicators that use the same scale as prices are plotted over the top of the prices on a stock chart. Examples include moving averages and Bollinger Bands or Fibonacci lines.
Oscillators: Rather than being overlaid on a price chart, technical indicators that oscillate between a local minimum and maximum are plotted above or below a price chart. Examples include the stochastic oscillator, MACD, or RSI. It will mainly be these second kind of technical indicators that we consider in this article.
First up, use the on-balance volume indicator (OBV) to measure the positive and negative flow of volume in a security over time.
The indicator is a running total of up volume minus down volume. Up volume is how much volume there is on a day when the price rallied. Down volume is the volume on a day when the price falls. Each day volume is added or subtracted from the indicator based on whether the price went higher or lower.
One of the most commonly used indicators to determine the money flow in and out of a security is the accumulation/distribution line (A/D line).
It is similar to the on-balance volume indicator (OBV), but instead of considering only the closing price of the security for the period, it also takes into account the trading range for the period and where the close is in relation to that range. If a stock finishes near its high, the indicator gives volume more weight than if it closes near the midpoint of its range. The different calculations mean that OBV will work better in some cases and A/D will work better in others.
Average Directional Index
The average directional index (ADX) is a trend indicator used to measure the strength and momentum of a trend. When the ADX is above 40, the trend is considered to have a lot of directional strength, either up or down, depending on the direction the price is moving.
When the ADX indicator is below 20, the trend is considered to be weak or non-trending.
The ADX is the main line on the indicator, usually colored black. There are two additional lines that can be optionally shown. These are DI+ and DI-. These lines are often colored red and green, respectively. All three lines work together to show the direction of the trend as well as the momentum of the trend.
The Aroon oscillator is a technical indicator used to measure whether a security is in a trend, and more specifically if the price is hitting new highs or lows over the calculation period (typically 25).
The indicator can also be used to identify when a new trend is set to begin. The Aroon indicator comprises two lines: an Aroon Up line and an Aroon Down line.
When the Aroon Up crosses above the Aroon Down, that is the first sign of a possible trend change. If the Aroon Up hits 100 and stays relatively close to that level while the Aroon Down stays near zero, that is positive confirmation of an uptrend.