Table of contents:
- 1 Information is priced in only gradually
- 2 Easy To Recognize Trading Trends In The Chart
- 2.1 But Isn’t A Trend Generally Always Future-Oriented?
- 2.2 What Is A Trend In Trading?
- 2.3 What Does A Trend Consist Of?
- 2.4 How Can You Recognize A Trading Trend?
- 2.5 At What Point Is A Trend Actually A Trend?
- 2.6 How Can You Trade A Trend As A Trader?
- 2.7 What Role Do Time Units Play In Trading?
- 2.8 Conclusion:
On the stock exchange, supply and demand determine the price. As long as supply and demand are not in balance, prices adjust – the price moves.
A trend is now characterised by the fact that one of the two sides predominates. During an upward trend, this can be, for example, the number of buyers or their purchase volume. A price movement in an upward direction lasting several days to weeks could be such an uptrend – it is characterized by smaller, intermediate countermovements or interruptions. In this case one speaks of a medium-term trend. Conversely, the scenario naturally also applies to the downward movement.
How is a trend created? The example of a medium-term uptrend just described provides further information.
In the first few days, more buy orders come into the market, the first investors and traders are in a positive mood and expect higher prices.
The reasons for this can be many:
- subjective assessment based on fundamental data
- Messages that cause purchases to be made
- Repurchase of short positions
- strategic positioning in the market
Concrete factors that lead market participants to adjust their expectations include central bank policy, economic data, corporate earnings, weather conditions, etc.
Information is priced in only gradually
Initially, the above-mentioned factors are not yet sufficient to move the price far: Markets only move abruptly on clear, surprising news.
Much more often, a gradual processing process of news of changed fundamentals or, of course, of the price change itself takes place.
The human psyche does not process information automatically, but slowly gets used to changing conditions – such as a new market direction.
In addition, most investors do not just act on their own decision – their purchases and sales must also be processed and approved by investment teams.
After all, events and news do not have the same relevance for every investor. Some investors adjust their positioning in the market immediately on the basis of a news item, while others initially view the actual impact of the news item with scepticism and only follow suit gradually. If these “stragglers” then enter the market as buyers, the price is pushed up further.
Trends reinforce themselves
How does a price movement affect the individual market participants? A market in motion causes traders and investors to trade. They either have to limit losses (i.e. buy back short positions in an uptrend), take profits, or are attracted by the strong performance of a market.
While some investors have positioned themselves in advance, others only follow once the price has actually moved. Not everyone wants to expose their money to the market “on suspicion” and instead waits for confirmation from the price.
This phenomenon can be observed on smaller (hourly chart and below) as well as larger (daily chart and above) time levels. Nevertheless, price movements on the daily chart are most likely to be continuous and fundamentally based. One of the reasons for this is that many more investors and traders adjust their positions on larger time frames than, for example, on the 5-minute chart (a chart that shows a time span of about one day).
The chart below illustrates schematically how a trend originates and continues.
Last but not least, this basic principle is based on psychological patterns of behaviour of investors and traders. Obviously the psychology of market participants will not change noticeably in the foreseeable future. “Follow the trend” is not just a temporary phenomenon, but will continue to prove itself in the future. It is worthwhile to participate in it!
Easy To Recognize Trading Trends In The Chart
If you want to trade successfully, you have to recognize the trading trend. In this article I will show you an easy way to determine the trend and the connection of the time units.
Many trading beginners dive into the world of candle charts and can’t see the wood for the trees anymore. What do the colours mean? Why are the candle bodies different? Is the market falling or rising?
In some trading book it said something about “You have to recognize the trading trend”. Another well-known stock market saying is “The trend is your friend”.
If you are not yet clear about the significance of a trend in an underlying asset such as a stock or index, don’t worry. By the end of the article you will have a very good understanding of how trends are created and how to recognize them.
We start the topic with a self-made definition:
A trend in stock market trading refers to a pattern of historical prices in an underlying asset.
But Isn’t A Trend Generally Always Future-Oriented?
Yes and no. A trend is much more of a current trend that is expected to reach the masses shortly. This applies to both fashion and stock market trading.
In stock exchange trading, we want to jump on a trend as quickly as possible and hope that it doesn’t end at exactly this moment.
What Is A Trend In Trading?
In trading we can trade in two directions – long and short. When we enter into a trade, we (at the beginning) start from a favoured trading direction and therefore have a market opinion. The Dax is rising now, I’m going long… the Disney stock is falling now, I’m going short.
I can assume a fast/volatile rise (downturn) or a calm upswing (downturn).
If we look at a chart, we see that there can be three trend phases in total:
- Upward trend
- Downward trend
- Sideways phase/Trendless
We will deal with all three phases in a moment.
The underlying instrument is initially in an uptrend, then changes into a longer downtrend. Market participants push the price with increasing volume out of the red trend-channel.
The volatile phase does not last long and a sideways-consolidation occurs. The market rests and gains new momentum (purple circle) before breaking out to the upside again. Again, a short downward-trend (red trend-channel) follows before entering a trendless phase.
The price development in an underlying instrument alternates between trends, volatile phases and trendless phases.
It is important that you as a trader accept the different phases! It will not always be a steep downhill or uphill phase. Anyone who has been around for a while may have noticed that volatile phases have the smallest share in the performance of an underlying asset.
What Does A Trend Consist Of?
A trend always consists of movement and correction. The movement is logically longer than the correction.
In an uptrend, it means that a high point is followed by a short reset and then a “higher” high than before is formed. In the downward trend it is the other way round. A low point is followed by a new low point after a short rebound to the top.
In the red trend-channel you can recognize this very well, since the course does not fall through like a stone in one go, but is carefully led downhill like a staircase.
This chart is a section of picture 1 and shows us once again the first downward trend. Here I have clearly marked the high points (green circles) and the low points (orange circles) once again.
Since it is a downtrend, a low is followed by an even “deeper” low.
In the next section you will learn how to recognize such trends on your own.
How Can You Recognize A Trading Trend?
You now know that there are uptrends and downtrends in a market and that the different phases always alternate.
The exciting question you have to ask and answer as a trader is
At What Point Is A Trend Actually A Trend?
The question is so interesting because you have to recognize the trend very early for successful trend trading. It is of no use to you if the trend has already run far away, because you know that every trend comes to an end once. At the same time, early speculation á la “a trend could emerge here and now” is dangerous. So it all depends on timing, as we will see in a moment.
There is a rule of thumb that you can apply when determining the trend:
You need at least three points to identify a trend. These 3 points are 1 low point and two high points (upward trend) or 2 low points and 1 high point downward trend).
You can see in the left picture the beginning of a slight downward trend, as a logical consequence of the impulsive rise. We already have three points for a potential trend channel. This becomes visible by connecting the two lows with a line and drawing a line at the same angle, starting from the (so far only) high point as a parallel.
We now assume that the price moves further within this trend-channel and will soon reach the upper line again (blue circle). There, it should “bounce off” and form another low within the channel.
If we now know or rather believe that the price will reach a certain level shortly, we can form a trade out of it.
How Can You Trade A Trend As A Trader?
The desire of every trader is to be able to predict the future price of a stock or other underlying asset.
Whoever manages to do this regularly will become rich. I deliberately didn’t write “always”, because that’s impossible. In trading we trade probabilities. When I see a trading setup that offers me a 70/30 chance/risk ratio, that is already very promising. The determination of a trend is a tool for this.
Once we have identified a trend, we have to find a suitable entry point. There are several possibilities.
Option 1: You wait until the price touches one of the two trend channel lines and then speculate on the rebound. If the upper line touches the upper line, you go short in the market, if the lower line touches the lower line, you go long.
Variant 2: You always trade only with the trend. If the trend is short, you enter the market at the top of the trend channel. In the opposite case, you go long. In the upper picture this would be a short entry at the level of the blue circle.
Variant 3: You trade in the direction of the superior trend. Therefore, you have to look from where the price has come before it forms the trend channel. In the picture above, the price comes with momentum from bottom to top and is clearly in an upward-trend. Accordingly, I will choose an entry “long” in the trend channel at the lower line.
Variant 4: You take the previous scenario, but consciously wait for an impulsive breakout from the trend channel and set your buy stop just above the upper line.
What Role Do Time Units Play In Trading?
If you look at the individual time units, you will see that a trend is visible in every chart. Of course, this is faster in the minute chart than in the hourly or daily chart (1 candle = 1 day).
I’m a friend of trading in higher time units, because there is more clarity here, the institutional investors also make their setups there and there are fewer fakes than in the minute chart.
It makes sense to compare the individual time units. Does it make sense to go long on the hourly chart when the daily chart screams for short?
Probably not, but in the end your trading style will decide. If you’re a scalper, that’s fine. For swing traders it is sometimes more difficult to trade contrary trends.
Take a look at the individual time units at your leisure and test for yourself which approach suits you and where trends are best to trade.
Now you know how to recognize a trading trend and how to use it for your day trading or swing trading.
As always in trading, there is no indicator or formation that always works. Of course, every trend ends at some point and we do not know when it is. We only trade probabilities and a visible trend helps to build a good CRV for a trade.
By the way, it is a fallacy that volatile phases allow for the big or bigger profit. A trend that is recognized in time usually allows several points of profit and often takes longer. Momentum, on the other hand, “kills” the trend and is quickly over again.