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What Is Trend Analysis
Trend analysis is a concept of technical analysis used by traders to forecast the future price fluctuations of an instrument based on past data.
Trend analysis is based on one of the pillars of technical analysis: history repeats itself.
With trend analysis, we try to anticipate future movements by analyzing the past. Trends identified in the past that has proven to be valid at one time would also work in future and will help to anticipate future trends.
What is A Trend
A trend is a prolonged market movement in one general direction, either up or down. A trend is basically the general direction of a market.
On a chart, a trend is usually formed by a succession of higher or lower trading ranges.
An uptrend marks a succession of higher highs and higher lows, while a downtrend marks a succession of lower highs and lower lows.
A trend may last for a matter of days, weeks, or months, depending on the time frame analyzed by traders.
Identifying the current trend direction is a very important phase in trend analysis.
The fundamental pattern of a trend on any time frame is this: a movement in one direction, a retracement in the other direction, and another leg in the original direction. Whether we look at trends on the one-hour chart or the weekly chart, we will find the same structure.
The significance of the trend will vary depending on the analyzed time frame.
Types of Trends
There are three types of trends:
- The primary trend, which represents an extended ascending or descending movement that usually (but not always) lasts for a large period of time
- Movements in the direction of the primary trend are interrupted by secondary trends in the opposite direction. These are also known as pullbacks or corrections that occur when the primary trend recorded a steep slope.
- In their turn, the secondary trends are composed of minor trends.
Primary Trends
A primary trend is considered as ascending (Bull Market) when each successive increase reaches a higher level than the previous one, and each secondary correction stops above the previous one. In other words, an upward trend is a succession of higher highs and higher lows.
A primary trend is considered as descending (Bear Market) when each successive intermediary downward move leads to successive low levels and each secondary correction stops below the previous one. In other words, a downward trend represents a succession of lower lows and lower highs.
Secondary Trends
Secondary trends, also known as intermediate trends, are relevant corrections that interrupt the price evolution in the direction of the primary trend.
- In a primary upward trend, the secondary trend will be a downward move, also known as a pullback.
- In a primary downward trend, the secondary trend will be an upward move, also known as a rally.
In general, a secondary trend corrects between one-third and two-thirds (most likely around 50%) of the increase or decrease of a primary trend.
Minor Trends
Minor trends are short-term fluctuations that have a lesser importance. The minor trends form the secondary trends. Usually, but not always, a secondary trend consists of three or more minor trends.
Most traders focus on the primary and secondary trends, and here’s the reason why. Minor trends often include a considerable amount of market noise. When you focus on minor trends, you can get caught by short-term volatility and lose focus on the bigger picture of the trend.
Trend Phases – Market Cycle
Understanding market cycles will help you to better identify trends.
It is believed that the market prices move based on the psychological perspective of two main groups: the so-called “smart money” and the general, uninformed public.
There are four phases of a market cycle:
Accumulation
Accumulation phase consists of sideways price action, during which “smart money” players buy carefully and skillfully, without moving the price. The uninformed public is unaware of what is going on.
Markup
The markup phase represents the classic uptrend. At this point, the uninformed public becomes aware of the price movement, and start to buy, driving prices higher.
Smart money players who bought during the accumulation phase may take some profits into the strength of the uptrend, or they may hold and wait for higher prices.
Distribution
The market enters the distribution phase when the trend end. In the distribution phase, the smart money players sell their positions to the uninformed public who is anticipating higher prices.
A part of smart money players might even sell more than they own and short the market.
On the charts, the uptrend runs out of steam, and the market goes into another sideways trading range. To the uninformed public, distribution phase is not very different from accumulation phase.
Markdown
The markdown phase represents the classic downtrend that follows the distribution. Smart money players who shorted during distribution phase will buy back some of their shorts into this weakness. Eventually, the uninformed public panics and sells their positions.
This panic usually marks the end of the downtrend.
A market cycle is dependent on the time frames analyzed by traders. An accurate analysis of the market cycle will help traders to better understand the trend.
In the perfect scenario, you would want to buy during the accumulation phase and sell during the distribution phase. However, it is difficult to pinpoint entries in the accumulation phase.
A more realistic view would be to buy during markup phase and sell during distribution phase, or at the beginning of the markup phase.
As long as you squeeze some profits from the market, you’ll be fine on the long run.
Trend Line Analysis
In order to determine a trend, you must master the trend lines. Trend line analysis is often underestimated by traders because it is perceived as being subjective.
Although this is not false, the trend line analysis should be the first step in determining the existence of a trend.
Trend lines are straight lines drawn on a graph connecting support points for an uptrend or resistance points for a downtrend. A trend line may rise, fall or move sideways. Trend lines connect two or more support points that define the trend.
Drawing trend lines is subjective, is not a precise science. Draw them correctly and you’ll have an edge over the market.
How to Draw Trend Lines
- In an uptrend, we look to connect the lows of the price. In a downtrend, we connect the highs of the price. A valid trend line connects two or more points that define the trend.
- We start drawing trend lines on higher time frames and the carrying them forward to shorter time frames.
- We identify the areas of support and resistance, the most significant levels being on the higher time frames.
- An uptrend line has a positive slope and acts as support. As long as the market price remains above this trend line, the uptrend is considered intact. A close of the price below the uptrend line suggests that a change in trend could be on the cards.
- A downtrend line has a negative slope and acts as resistance. As long as the market price remains below this trend line, the downtrend is considered intact. A close of the price above the uptrend line suggests that a change in trend could be on the cards.
Trend Lines Relevance
The relevance of a trend line depends mainly on its length, its number of retests and its ascending or descending slope.
Length
The length of the trend line is an important factor. A 3-4 weeks trend is of minor importance if the trend lasts for 1-3 years, for example.
A break below or above a trend line with an important length represents an important signal.
Number of trend line re-tests
A trend line is more important if it has been retested many times. That’s why a trend line acts like a dynamic area of support or resistance. Each line retest contributes to the importance of support or resistance.
Extending the trend line after a breakout is very important because its role of dynamic support / resistance will reverse.
This means that if an uptrend line retested several times in the past is broken to the downside will become a resistance area.
Also, if a downtrend line retested several times in the past is broken to the upside will become a support area.
Ascending or descending slope
A very steep trend is difficult to be maintained and is therefore likely to be easily broken, even by short lateral movements.
All the trend lines are eventually broken, but the steepest trend lines are the soonest broken. Usually, a breakout of a trend with a steep slope is more likely followed by a trend continuation than a reversal.
A steep trend line is the result of an accelerated increase or decrease in the short term. In this case, the trend line will have a higher angle and is less likely to provide solid support or resistance.
From my experience, trend lines with 30-45 degree angles represent solid indicators for the main trend.
Trend Analysis Using Technical Indicators
For a proper trend analysis, the majority of traders use technical indicators. Technical indicators analyze historical data in order to forecast future price trends.
Unfortunately, the majority of technical indicators are lagging, meaning that they follow the price. A lagging indicator will generate signals late into a trend.
I’m not saying that a lagging indicator can’t be reliable in trend analysis. We just have to choose the indicators that would bring the missing puzzle to our analysis.
I prefer to add to my trend analysis several leading indicators. Leading indicators are able to precede the price movements of an instrument due to their predictive qualities.
While, lagging indicators (RSI, Stochastic Oscillator, moving averages, Bollinger Bands etc.) follow price movements and don’t have reliable predictive qualities, leading indicators are able to anticipate when major moves in the markets would occur.
Leading Indicators:
- offer an early warning about the current market price
- predetermine which direction to trade
- offer accurate target prices and optimal entries on the market
In trend analysis, finding a balance between the leading and lagging indicators is the answer.
- We could use a leading indicator to determine the direction of the trend and take our market entries based on signals offered by a lagging indicator.
- We can use a lagging indicator to enter the market and watch closely a leading indicator, to warn us about a possible trend change and to find an exit point.
3 Technical Indicators for Trend Analysis
There are a few decent indicators, very useful for trend analysis. Here are the most useful 3 indicators:
On-Balance Volume
On Balance Volume (OBV) is a momentum indicator that relates volume to price change. On Balance Volume indicator shows if market’s volume is flowing into or out of an instrument.
Remember when we mentioned before about smart money and the uninformed public? Well, the main assumption is that On Balance Volume movements precede price changes. As the volume is the main fuel behind a trend, OBV is designed to anticipate when major trends in the markets would occur.
It is believed that “smart money” can be seen accumulating into the instrument by a rising OBV and when the public comes along into the instrument, both the instrument and the OBV will increase.
On-balance volume is a leading indicator, able to anticipate when major moves in the markets would occur.
Moving Averages
The moving average (MA) is probably the most well-known and heavily used indicator in technical analysis. The moving average effectively captures the trend of a financial market in an easily identifiable manner.
Traders use different settings of moving averages in their trend analysis. Some are interested in the long-term trend, others want to determine the short-term trend.
Identification and confirmation of the market trend are one of the most important roles of a moving average.
- A market is considered to be in an uptrend when the price is above a moving average and the MA’s slope is upward
- A market is considered to be in a downtrend when the price is below a moving average and the MA’s slope is downward
Moving averages are lagging indicators as they are based on past information. So, keep in mind that moving averages don’t predict new trends, just confirms the market trends once they have been developed.
Average Directional Index – ADX
ADX tells traders whether the bulls or the bears are in control on the market.
In a trend analysis, ADX reads as follows:
- When ADX is above 25, trend strength is strong enough for strategies involving trend following
- When ADX is below 25, traders must avoid trend trading strategies as the market is in accumulation or distribution phase
- When ADX is above 25 and +DMI is above the –DMI, ADX measures the strength of an uptrend.
- When ADX is above 25 and +DMI is below the –DMI, ADX measures the strength of a downtrend.
- Values over 50 of the ADX indicate a very strong trend
Despite the fact ADX is a lagging indicator that follows the price, it allows traders to see the strength of bulls and bears at the same time.
Market Trend Analysis Examples
Let’s look at DAX30 Index and perform a simple trend analysis.
As we mentioned before, we start our trend analysis starting with higher timeframes.
Monthly trend – UPTREND
After drawing the most relevant trend lines and analyzing the slope of the 200-period exponential moving average, we can safely say that we are currently in an uptrend.
The uptrend is confirmed by the on-balance volume, which also indicates a strong bullish market.
Weekly trend – UPTREND
The weekly trend also shows a strong uptrend, with the price staying 95% above the 200-period moving average. The slope of the moving average is positive, indicating a bullish outlook.
Also, the on-balance volume reveals that bulls are in control of the market.
We have 2 major trend lines acting as support if the trend will record a correction (secondary trend).
Daily Trend – SLIGHTLY UPWARD
On the daily chart, we have some mixed signals. The trend is still upward, with the OBV in buy mode.
However, the price is now trading around 200-period exponential moving average. The market is around a decision area.
The price recently broke a relevant trend line, which could bring some downward pressure on the main trend.
H4 Trend – No trend
On the H4 chart, things get messy. There is no visible on trend on the market, but if I have to choose between an uptrend and a downtrend, I would choose a downtrend.
First, if we take a look in the past, we see that the price stood more time below the 200-period exponential moving average. The same situation can be applied to the OBV. Clearer signals were generated on the short side.
Now the price trades below the 200 EMA, and its slope starts to point downwards.
H1 – No trend
On the H1 chart we also see a trading range, with lots of sideways price action.
The bias is however to the downside, with the price trading below the 200-period exponential moving average.
The OBV also suggest a short-term bearish pressure.
The fact that the price closed below an important trend line, tested 4 times in the past, indicates that the bears are in control of the market.
Note: I don’t analyze charts below H1, as they often offer a lot of market noise.
Final Thoughts
A proper trend analysis is critical to the successful trading of that market. Used in the right way, trend analysis will offer you a substantial competitive advantage over other market participants.
The reality is that no one knows how high or how low a market will go. No one knows when a market will move. But we can follow a trend to increase our chances to profit from the markets.
Remember, trend following is the most profitable and consistent trading style. Adopting a smart trend analysis might give you that edge to succeed in financial markets when trading.
1 thought on “How To Do Trend Analysis (How To Analyse Market Trends)”
Hi sir , i am not familiar with candlestic, I use bar chart