When you understand what the price charts look like, you can then move on to looking for trends. It is important to understand the basic concept of a trend: A trend simply shows a difference between the supply and demand for a company’s shares. When there are more sellers than buyers, the stock will move down. When there are more buyers than sellers, the stock will move up. When the number of buyers and sellers is about the same, the stock price will move “sideways.” All trends eventually come to an end. At the end of a trend, there is usually a “reversal” where the trend is broken and becomes a trend in the opposite direction.
In addition to direction, trends can be classified by duration. Minor trends last from a few days to a few weeks. Intermediate trends last from several weeks to several months and major trends last from several months to several years.
How to Spot a Trend
You can’t spot a trend with just one price point. To find a trend you will need at least two points of a top or bottom, but you will need 4 points to confirm a trend. When you have these points, you can draw your trend line.
In a rising market, you will have four bottoms to draw a trend line from. However, these bottoms will often be out of line, so you will have two upward trend lines.
If the next bottom is outside of these two lines, you will draw another line, resulting in “fan lines” showing that the trend was likely broken.
For a downtrend, these steps are the same, but the lines will appear in the opposite direction.
A trend channel is made up of two lines connecting the tops and bottoms of a stock price’s movement. Knowing that a stock fluctuates between these prices gives you a “buy” zone and a “sell” zone. When the price is closer to the bottom you will want to buy, and when the price is closer to the top you will want to sell. However, you will also want to make sure that the trend channel is wide enough to cover the price of commissions because you will be unable to profit if the difference between buying and selling is not large enough.
After a trend channel has been established, a warning sign of the trend being broken is when the price falls to return to the top of the trend channel. This signals that the price could break outside of the channel when it begins to decline.
Support and Resistance:
Support lines and resistance lines are based on the supply and demand of a stock. The support line is the price at which nobody wants to sell, and the resistance line shows the price at which nobody wants to buy. These points move over time, but they always exist.
Resistance and support levels are never permanent. When these levels are “penetrated,” it is called a “breakout.” A breakout is often caused by a change in the company’s fundamentals. After a breakout occurs, the prices will either stabilize with new resistance or support levels or will return to their original levels.
If the price returns to previous levels, this is called trader’s remorse. This can be temporary or permanent depending on the amount of volume that accompanies the breakout period and the remorse period. If the breakout period has high volume but the remorse period shows low volume, there is likely to be a new trend coming. If the breakout happens with normal or low volume and the remorse period has high volume, then the breakout was a “trap.”
This graph shows a breakout with trader’s remorse. The breakout was, in fact, a trap.
Profiting from Trends
Being able to spot a trend is nice, but it is not very useful unless you are able to profit from what you see. You can profit from a trend in two ways. You can buy when an uptrend is in play and sell when a downtrend is in play, or you can wait for a breakout and trade on the anticipation of a new trend.
It is a simple concept, but it does not always work. For most technical patterns, the volume is used as a guide to determine the authenticity of a trend or a break from a trend. If the volume is high, then there is a good chance that the new trend is real. But since there is no guarantee, you should not commit significant amounts of money to pattern trading until you become comfortable with finding trends.Conclusion: Can you be a Technical Analysis Trader?
You can certainly be a technical analysis trader if that is your desired trading strategy. But to know whether technical trading is right for you, it is helpful to assess your personal comfort level and ability. Here are some questions that will help you think about how technical analysis will fit for you:
Are you more comfortable with the idea of stock prices following the success of the business (fundamental) or following the market’s feelings (technical)?
Do you want to see fast results on your trades (technical), or are you willing to wait for business conditions to confirm your analysis (fundamental)?
Are you comfortable using a system that is inherently uncertain and very stressful?
Can you commit a significant amount of time each day to analyzing and tracking your trades?The point here is that technical analysis can be successful, but a certain type of person is more likely to excel. People using technical analysis concentrate on the share price, believe that this price is driven by the psychology of investors, and use a chart to track these trends. If you don’t have those qualities or share these beliefs, then another trading method might work better for you.