Following the trend is the most important principle of technical analysis.
Let’s focus for a moment what exactly the trend is.
We distinct three types of trends:
- uptrend,
- downtrend,
- sidetrend (horizontal trend, sideway).
Uptrend occurs when consecutive highs are on the higher price level and consecutive lows are on the higher level.
Uptrend
Downtrend is opposite to uptrend. Downtrend occurs when consecutive highs are on the lower price level and consecutive lows are also on the lower level.
Downtrend
Sidetrend is when there is no clear uptrend or downtrend. Of course, movements of price occur within some range. Sidetrend is rather informal concept; it doesn’t have strict mathematical definition. Very often it is said sidetrend is not a trend on its own but a lack of trend.
Sidetrend
How we can apply this knowledge? Take a look at short example.
Based on this theory we are looking for signals to open (buy) and close (sell) positions.
When stock price is in downtrend, we are waiting for a shift.
New low is on a higher level than the last one and price rises above last high. It is very likely that uptrend emerged and it is strong signal to buy stocks. We set the defense on the last low - so we sell stocks if the uptrend is not confirmed by price movement and drop below last low.
If the uptrend is confirmed, we keep stocks and keep moving defense line to the level of last low. If this level is crossed by the price, it is signal to close position.
Keep in mind that such trend analysis can be done in short-term, mid-term and in long-term scale. The shorter term, the more signals to open and close you get; the longer term, less signals but more accurate.
This is very effective and simple way of investing, with best results for mid- and long-term. However, we should always support it with other tools to confirm our further decisions.
What other tools? I will write about it soon.
