Understanding Trend Analysis

Listed below are several trend following techniques; understand its use in charting and how they are to be implemented.

Topics covered are:

• What are trends and the different types of trends.
• How to draw a trend line.
• Trend movements and trend channels.
• Support and resistance levels of a trend and how to identify them.

I. Trends

The use of trends is to determine the relative direction of prices in a market. They are identified as uptrend, downtrend or flat. Without a trend, prices will remain flat and unchanged. For trading to be profitable, movements in price must occur or trend. FOREX, though a very trendy market has many explosive short-term price movements that can lead to significant profit opportunities. There is a popular saying among investors, “the trend is your friend until the end”. Keep this in mind when trading.

A. Up trend – In an up trend the base currency is appreciating in value.

B. Downtrend – In a downtrend the base currency is depreciating in value.

C. Sideways Trend – The price are moving within a narrow range and are neither appreciating or depreciating in value.

A sideways trend represents an area where prices move in a flat and narrow range for several days or weeks. This type of market movement is often termed a period of congestion. Rapid price movements usually follow a breakout from a period of congestion, most of the time in the direction of the original trend.

Note: In FOREX, profit is possible in both market directions. You can buy or sell a currency against another and profit from price fluctuations regardless of trend.

D. Trend Classifications – Within a trend there are smaller trends that make up the overall trend. And they can be classified as long-term (periods of one month and longer), medium-term (one week to a month) and short-term trends (24 hours to one week).

II. Drawing Trend

Drawing Trends point being higher than the first. The opposite is said for a downtrend, where two peak points are connected left to right

Trend lines will serve as the most important tool to any trader. The ability to first determine a trend direction is the basis of all-technical trading. Back to the business cycle, a market moves in a series of waves, with periods of expansion and contraction. Through these changing phases, peaks and troughs will form, and with these points trend lines are drawn.

On an uptrend, you connect two trough points from left to right with the second trough with the second peak point being lower than the first.

Note: Uptrends will always connect trough points and downtrends will always connect peak points.

III. Trend Movements And Trend Channels

Trend movements and trend channels will change according to market conditions, and it is the ability to recognize these changes that will help your trend analysis. Drawing trendlines will help to determine when a trend is starting, ending or changing. Also, they provide important support and resistance levels, entry and exit points.

Each one of the following charts is examples of a trend movement or trend channel. Recognize them, as they will become important techniques to trade by!

A. As momentum builds and volatility increases, prices will accelerate. In this example we see an increase in upward momentum in which a 2nd and 3rd trendline may be drawn to follow the price trend.

Note: The greater the momentum within a market the more volatility is present. With more market volatility, the sharper the angle of momentum to one side. And the sharper the angle of momentum the less sustained that trend becomes.

B. When prices have broken the uptrend line and closed above it, this indicates the start of a new trend.

Similiarly, when prices break an uptrend line and closed below it, this also indicates the start of a new trend. But a close below the uptrend line may indicate a temporary changing of trend direction.

C. Trendlines show support boundaries under prices. The boundaries may be used as buying areas.

D. When prices trend between two parallel trendlines they form a channel. A channel is effectively two trend lines, which can be drawn in parallel to each other, the higher line acting as the resistance line, the lower line as the support. As with trends channels it can be upward, downward or sideways. In an up channel the support line is the most important trendline, in a down channel the resistance line is the most important.

Note: When prices hit the bottom trendline this may be use as a buying area and when prices hit the upper trendline this may be used as a profit taking area and vice versa depending on trend.

IV. Support And Resistance Levels

Initially people who begin to look at the market in a technical way, but without constructing charts look for psychologically important numbers at which they think the market will look to reverse direction for a period of time. This is only one of the many approaches used in charting.

Support can be defined as the level from which prices have fallen to, made a dip in the market and then retraced. The reverse is true of resistance levels where price have risen to, made a peak before retracing back to the downside. The more often retracements happen at or around key levels the stronger the support or resistance level becomes.

In psychological terms these levels work because buyers or sellers remember that there was a sharp reaction from the same level last time it was seen. Therefore, at a support level sellers are tempted to take profits, new sellers are reluctant to take positions and buyers are keen to enter the market.

It is always noticeable however; that once a major level has been broken buying (breaking a resistance) or selling (breaking a support) will accelerate.

If a support level is broken, this will then become a resistance level for any rally, while a broken resistance will become a support level for any pullback.

Support and resistance levels take on an added significance when used in conjunction with momentum or relative strength, the latter two factors giving a good indication whether a particular level will hold or be broken. These will be covered in Universal Mathematical Models.