Trend Analysis

Now that we have established the various shares chart types used in technical analysis of the share market, we can introduce some basic rules to provide us with guidance as to whether share prices are rising, falling or moving sideways.

Uptrends

The diagram to the right illustrates how simple it is to define an uptrend. Notice how each high is higher than the previous high, while each low is also higher than the previous low. This is the technical definition of an uptrend: a series of higher highs and higher lows. In order for a market to be in an uptrend it must be making higher highs AND higher lows, sometimes you will see higher highs and lower lows during volatile conditions; this is not considered an uptrend. If a market is not making higher highs and higher lows than it is not in an uptrend, this does not automatically mean it’s in a downtrend either though, let’s continue.

Downtrends

The diagram to the right illustrates a downtrend. A downtrend occurs when a stock is making lower lows AND lower highs. Notice how each high is lower than the previous one and each low is lower than the previous one. Technically speaking, buying stocks that are in a downtrend is not what you want to do. It is much safer to wait until an uptrend emerges in the price chart of the company you are considering buying shares in. Markets are not as simple as uptrends and downtrends however, there are times when the market is neither in an uptrend or a downtrend, but consolidating in a sideways manner. We consider this next.

Sideways movement

Notice in the diagram at right prices never reach a point where there is a higher high AND a higher low, after the market registered the second higher high, notice that the market then made a lower low. There is neither an uptrend nor a downtrend, the market is simply trading sideways, or consolidating, with no real indication of clear direction.

There are ways to trade consolidating markets; we will get into this briefly when we cover support and resistance levels in the next lesson. However, generally speaking it is best to stand aside and do nothing during sideways trending price action.

Identifying a change of trend

Now that we have identified an uptrend, a downtrend, and a period of sideways price movement, we can describe some basic ways to make use out of this information. Obviously we would prefer to get out of our long share positions as soon as a downtrend develops and we would like to enter into a long share position as soon as an uptrend is confirmed. Let’s check out how to identify a change in trend.

Notice in the diagram to the right it is easy to see that initially there was an uptrend in place. There is a series of higher highs (H1, H2) AND a series of higher lows (L1, L2, and L3). Notice however that H3 is LOWER than the previous high. This is the first warning that a change in trend may be coming, as the criteria for an uptrend is no longer being met.

The market is no longer in an uptrend; at point H3 we still have higher lows but a lower high. We need both higher lows and higher highs to maintain an uptrend. At point H3, there is no trend either up or down, we can describe the market as neutral or range bound. Notice how price then turns lower and broke the level market by L3. If you look carefully something major has happened. We have a lower high at H3 and we have a lower low once L3 is breached. At this point a downtrend is in place at the point marked by the arrow because we now have a lower high AND a lower low.

Next in our technical analysis tutorial series we will introduce shares support and resistance levels.