How to Identify Trend in Trading – An Intro Guide

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In stock trading, you can make money from an uptrend or a downtrend.

Downtrends tend to move faster than uptrends, which is why you will find some traders who opt to only short sell stocks in order to capitalize on the quick price action.

Research shows that stocks can trend more than 30% of the time. The rest of the time, the stock moves sideways.

Want to know how to identify and trade a downtrend?

In this post, we discuss what a downtrend is, and how to spot and trade them.

What Is a Downtrend?

A downtrend is when price action in a stock is moving lower over a period of time and is most recognizable by prices creating lower lows and lower highs.

Stocks in a downtrend continue in a trend down until certain market conditions change the direction. A downtrend is typically reversed by the supply of shares investors are planning on selling compared to the demand of investors who want to buy the stocks

What you need to know is that a downtrend is composed of two types of price waves. They include:

  • Impulse
  • Correction

For example, if Company A stock price was $13, then drops to $12.50, then rallies to $12.75 and again falls to $11.75. These price movements will create a price wave. What you need to know is that Impulse price waves are larger ($12.75 to $11.75), while corrective waves are much smaller $12.50 to $12.75.

Trends form when the stock price makes progress. It can either be in one direction or another. If the impulse wave moves down, followed by a corrective wave up, it means the stock price has made a downside move.

In stock trading, a downtrend will continue as long as the impulse waves down and corrective waves up.

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Key Characteristics of a Downtrend

Several things characterize a downtrend which is easily recognized in charts as you can see below:

Lower Peaks and Troughs

Lower peaks and troughs characterize downtrends with lower lows and lower highs taking place as you can see in the graph above.. A peak refers to the highest point between a contraction and an economic expansion. A trough is also a stage in the business cycle, just like a peak.

But, unlike a peak where activity is increasing, in a trough, activity or prices are bottoming. A trough in a business cycle typically marked by layoffs, declining business sales, and earnings as well as higher unemployment.

It’s also important to note that trends can form on different time frames. You can have intraday trends as well macro trends on daily and weekly charts.

News Catalysts

News catalysts is another characteristic that can push stocks into a downtrend. Take the example of CBD stocks. When the US Farm Bill passed legislation to legalize the industrial hemp growth, it sparked interest among investors.

Why? There was a massive chance for the legalization of medical and recreational marijuana. The news had a significant effect on CBD stocks, which resulted in an uptrend. If it were negative news, for example, medical marijuana was not legalized, it would affect CBD stocks.

This would result in a downtrend where a majority of investors will be selling, but a few investors would be buying. Apart from news catalysts, earnings reports and changes in management can result in a downtrend too.

Increase in Market Participants

When the stock price goes downs, the number of sellers increases, which means supply exceeds demand. The increase in market participants who are now convinced that the declining stock price is temporary will begin to rise. As such, the number of buyers buying the stock increases while the number of sellers decreases.

How to Trade a Downtrend

A downtrend occurs across all assets and time frames. Traders can trade them over longer-term time frames such as daily, weekly, and monthly or short-term charts like a tick and one-minute charts. What you ought to know is that the same trend trading concepts apply whether the trader is looking at a daily, weekly, or monthly chart.

If a trader is viewing a one-minute chart, traders seek trades with small trends while on a weekly chart, the trader seeks trades that last for months or even years. In stock trading, a majority of traders avoid downtrends.

Why? They focus on uptrends. Since downtrends are in all time frames, traders identify the lower peaks and troughs early. By identifying downtrends, traders can discover new trading opportunities.

Tools

There are several tools traders can use to identify or spot downtrends. One of those tools is a stock screener. While a stock screener lacks a specific tool for downtrends, you can use features such as Day Gainers, technical, and fundamental indicators such as moving averages or relative strength index. You can also identify downtrends using volume and volatility.

Apart from the stock screener, use the line graph of a stock chart. If you look at a line graph, you can spot emerging trends. All you have to do is check different time frames. If there are peaks and troughs in the chart, that indicates a trend.

Use trend lines during trend analysis. How? By creating a trend line over a stock chart’s high pivot points or under pivot low points. This is a great visual indicator of resistance and support. It also offers a clue to the direction of the price change and speed.

You also have the Average Directional Index, which can show the strength or magnitude of downtime at a certain point. In fact, the Average Directional Index can help traders decide whether or not to enter a short position.

Short sellers profit from downtrends by borrowing then selling the stock immediately with an agreement to buy them in the coming future. Also known as short selling, traders benefit from the difference between the lower future price and current sale price.

If you are planning on short selling, do so during the corrective wave. Using Fibonacci retracement levels will isolate sections where correction stops and reverses. You can also wait for the correction to stop rallying.

By doing so, you allow the price to move sideways, and when it starts to drop, make a short trade. To manage risk, place a stop loss on every trade. Remember, to exit a short trade with a profit; the prices will need to be lower than what you sold them for.

Trading Tips

  • Look for prices to reach previous highs but are not able to break through. This is a good indication that buyers are no longer seeing value in the stock and we could be setting up for a move lower.
  • Use previous highs as a stop location
  • Look for a break in previous lows to confirm the downtrend
  • Profits should be taken as prices flush below previous lows and stops should be adjusted to the last previous high.

Final Thoughts

There are a couple of mistakes you need to avoid.

First, never fight the overall trend on the higher time frames. If you do so, you may find yourself in a downtrend with no reason to buy. Second, never trade too big. Trends are temporary. Even if they are strong or have a potential for making profits, never risk too much on any one trade.

This is true, especially if you have a small account or just starting. Don’t be greedy. What we recommend is to start small and scale-up. By trading small, you gain crucial knowledge and experience. As such, you will be confident about increasing your trading sizes.

Lastly, take time to learn. To be successful at trading stocks, you need to keep learning. Stay on your toes at all times. How? By keeping abreast of what is happening in the market. To do that, commit yourself to learning and surrounding yourself with more experienced traders.

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Available research data suggests that most day traders are NOT profitable.

In a research paper published in 2020 titled “Do Day Traders Rationally Learn About Their Ability?”, professors from the University of California studied 3.7 billion trades from the Taiwan Stock Exchange between 1992-2006 and found that only 9.81% of day trading volume was generated by predictably profitable traders and that these predictably profitable traders constitute less than 3% of all day traders on an average day.

In a 2005 article published in the Journal of Applied Finance titled “The Profitability of Active Stock Traders” professors at the University of Oxford and the University College Dublin found that out of 1,146 brokerage accounts day trading the U.S. markets between March 8, 2000 and June 13, 2000, only 50% were profitable with an average net profit of $16,619.

In a 2003 article published in the Financial Analysts Journal titled “The Profitability of Day Traders”, professors at the University of Texas found that out of 334 brokerage accounts day trading the U.S. markets between February 1998 and October 1999, only 35% were profitable and only 14% generated profits in excess of than $10,000.

The range of results in these three studies exemplify the challenge of determining a definitive success rate for day traders. At a minimum, these studies indicate at least 50% of aspiring day traders will not be profitable. This reiterates that consistently making money trading stocks is not easy. Day Trading is a high risk activity and can result in the loss of your entire investment. Any trade or investment is at your own risk.

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Citations for Disclaimer

Barber, Brad & Lee, Yong-Ill & Liu, Yu-Jane & Odean, Terrance. (2020). Do Day Traders Rationally Learn About Their Ability?. SSRN Electronic Journal. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2535636

Garvey, Ryan and Murphy, Anthony, The Profitability of Active Stock Traders. Journal of Applied Finance , Vol. 15, No. 2, Fall/Winter 2005. Available at SSRN: https://ssrn.com/abstract=908615

Douglas J. Jordan & J. David Diltz (2003) The Profitability of Day Traders, Financial Analysts Journal, 59:6, 85-94, DOI: https://www.tandfonline.com/doi/abs/10.2469/faj.v59.n6.2578

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The Complete Guide How To Draw and Use Trend Lines Perfectly [9332]

How To Draw and Use Trendlines – Trend lines have become widely popular as a way to identify possible support or resistance. But one question still lingers among Forex traders – how to draw trend lines perfectly?

Trendlines are very useful in helping you determine the trend, and also the strength of that trend as well. Today we are going to take a closer look at this important price action analysis technique.

As the name implies, trend lines are levels used in technical analysis that can be drawn along a trend to represent either support or resistance, depending on the direction of the trend.

Think of them as the diagonal equivalent of horizontal support and resistance.

Trendlines are a great place to start. All you have to do is identify trends on a chart, draw your trendlines and then watch how the price interacts with them.

These trend lines can help us to identify potential areas of increased supply and demand, which can cause the market to move down or up respectively.

In this article we will look at:

  • How to draw trendlines
  • How to use trendlines in your trading

To draw forex trend lines perfectly, all you have to do is locate two major tops or bottoms and connect them.

Yep, it’s that simple.

Let’s take a look at a trend line that was drawn during an uptrend.

Notice how in the chart above, the market touched off of trend line support several times over an extended period of time.

In this manner, the price of the pair records higher bottoms and higher tops.

This trend line represented an area of support where traders can begin to look for buying opportunities.

Now let’s take a look at a trend line that was drawn during a downtrend.

Notice how in the chart above, the market touched off of trend line resistance several times over an extended period of time.

In this manner, the price of the pair records lower bottoms and lower tops.

This trend line represented an area of resistance where traders can begin to look for selling opportunities.

Let’s Draw Trendlines

In order to draw a trendline (bearish or bullish), you first need to identify a trend. So, let’s have a look at a chart.

Can you find a trend in the chart above?

It’s hard to do so visually without the help of a trendline. But once we add our trendline to the chart, you can see that there are at least six minor trends here.

The very first thing to know about drawing trend lines is that you need at least two points in the market to start a trend line. Once the second swing high or low has been identified, you can draw your trend line.

Let’s look below.

Notice in the chart above, we have two main points at which we can start to draw our trend line. Once this level has been established, we can start to look for bearish or bullish price action to join the rally.

The question is whether you should use the candle-wicks or the candle-bodies to draw the trendlines!?

The answer is CONFLUENCE.

NOTE : Never think of the trend as contained within of a single line. The trend is not a line, but an area.

Whenever you get the best and the most contact points and confluence around your trendline, that’s how you draw it.

There are no fixed rules about whether wicks or bodies are better.

Just look for a trendline that gives you the most confirmation without beeing violated too much. Having said that, I don’t mind violations of just candle wicks as much as of candle bodies.

Now I will show you how to spot and trade corrections of trending moves.

However, I would like to emphasize that counter-trend trading is for advanced traders. The reason for this is that it is a risky initiative to trade corrections.

We can get the following information from trendlines:

  • Is a trend losing or gaining strength? (The trendline angle tells us that)
  • Trendlines can be support and resistance
  • A break of a trendline after a trending period can be a meaningful signal

One thing to note about using trend lines in this way is that it works best when you have a really clean trend line with three or more touches.

The more obvious the trend line is, the better this strategy will work.

Let’s look below.

Notice how shortly after breaking trend line resistance, the market came back to retest the trend line as new support and formed a bullish pin bar in the process.

This gave price action traders an opportunity to buy.

This is a great way to use trend lines to spot potential reversals in the market. It is without a doubt one of the best ways to catch a big move as a market changes direction.

Forex Trading Skill: How To Identify The Trend The Easy Way!

In this Forex trading vlog, I share a technique on how to identify the trend in the Forex market easily. Vlog #235.

How To Identify The Trend – Step-By-Step

It comes down to 3 steps:

  1. Selecting the right timeframe based on your trading style
  2. Looking at past highs & lows (I cover this in details)
  3. Trading as usual based on the trend

Common Mistakes & Things To Be Aware Of

One of the big mistakes I see new traders make is looking for the “perfect alignment” across all timeframes. Very rarely will the price be in the same direction on all timeframes. Requiring that in your trading plan is a simple way to feel confused.

In addition to that, although we often hear that an uptrend is marked by higher highs and higher lows, it’s important to mention that we must have BOTH higher highs and higher lows. Having only one of those criteria will likely result in a random phase of the market, which isn’t always good to trade.

Are you using a similar technique to identify the trend in the Forex market? Has this article helped you? Comment below and let me know!

If you are aspiring to Forex but wonder how to put together a solid trading plan, I recommend you grab my FREE One-Page Trading Plan Template. It will help you simplify your trading strategy on a single page!

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