Previously we have discussed with you two approaches, Fundamental Analysis and Technical Analysis that investors and traders follow to make predictions about future asset prices.
Today, let’s look at one of the most basic concepts in technical analysis—market trend analysis. Common queries among new traders & investors include “How to do trend analysis, What is RSI in the stock market? and What does moving average in the stock market mean?" If you’ve been wondering something similar, read on.
First off, let’s understand what a trend is.
In technical analysis, a trend refers to the general direction in which prices of an asset are moving. When you say a stock/index/commodity/currency is in an uptrend you mean, in general, prices are advancing. As against that, prices drift downwards in a downtrend. If you can’t clearly identify the direction of price action, you may conclude that the price trend has been sideways.
To identify trends you can simply plot a price chart and pay attention to trend formations.
Trend analysis helps you figure out
What is a trend line?
In plain English, a diagonal line drawn on a chart to denote the support and resistance of an underlying trend is called a trend line. The support zone is a price level where falling prices find props. As against that, resistance is a price zone that tends to freeze an upward price movement.
Higher highs and higher lows denote an uptrend; whereas lower highs and lower lows depict a downtrend. Usually, trend lines are drawn by joining either the pivot highs or lows.
A trend line depicting a stock in an uptrend
A trend line showing a stock in a downtrend
Oscillating in a channel: sideways movement
(For illustration purposes only; shouldn’t be construed as a recommendation to trade under any circumstances)
Moving averages
Moving average is an average price of an asset over a given time frequency. For example, a 10-day moving average will give you the average price for the past 10 days so a 60-day moving average will give you the average price for 60 days.
Similarly, you can set an hourly, daily, weekly and even monthly frequency depending on the timeframe you want to use for your analysis.
Moving averages can be further classified as simple moving averages and exponential moving averages. While the former is nothing but an arithmetic mean for the given time-frequency, exponential moving averages give more weightage to the most recent data. As a result, they factor in volatility.
For now consider simple moving averages to get conceptual clarity.
Moving averages help ignore intra-period fluctuations and obtain consistent prices. Moving averages are normally used as the first-level trend indicators meaning when prices move above or below a specific period, they can generate a bullish or bearish signal. And a trader/investor can initiate a trade around these levels.
Here’s an example.
Chart 1: Identifying a bullish trend on a technical chart
This chart represents daily price movements
The red line indicates a 10-day moving average whereas the green and purple lines depict 30-day and 60-day moving averages respectively.
(For illustration purposes only; shouldn’t be construed as a recommendation to trade under any circumstances)
As you can see in chart 1, lows and highs on a running basis are generally higher than their previous lows and highs. The recent movements as depicted in chart 1 might appear sideways but the overall structure is still bullish. Prices have taken the support of 10-day and 30-day averages and haven’t slipped below the 60-day moving average line.
In other words, for a positional trader having a medium-term view, a close below the 60-day moving average may become a crucial level to watch as it may hint at a potential reversal in the present uptrend.
How does this work for a bearish trend?
The moving averages become price resistance points in a bearish trend as we can clearly see in the chart below. A durable close above the 60-day moving average could be vital as it might signal a reversal of the downtrend in the given chart 2.
Chart 2: Analysing a bearish trend in Amara Raja Batteries
The chart represents daily price movements
The red line indicates a 10-day moving average whereas the green and purple lines depict 30-day and 60-day moving averages respectively.
(For illustration purposes only; shouldn’t be construed as a recommendation to trade under any circumstances)
Chart 3: Sideways pattern explained by Adani Enterprises Chart
The chart represents daily price movements
The red line indicates a 10-day moving average whereas the green and purple lines depict 30-day and 60-day moving averages respectively.
(For illustration purposes only; shouldn’t be construed as a recommendation to trade under any circumstances)
As you can see, Sideways patterns can be a bit frustrating. A trader may sometimes take a position once the prices breach the key moving averages only to realise that they are going to settle in a range, sooner rather than later.
Identifying chart patterns and toying with moving averages is a good starting point but to spot trends more accurately and gain meaningful insights thereof, you need to go a step further.
How to gain the most from trend analysis?
You should always read price charts in conjunction with momentum indicators which are popularly known as oscillators. If price charts talk about price changes, oscillators highlight how slow or fast the pace of price change has been thereby helping you identify the trend momentum.
When price charts and oscillators are in agreement, together they can generate powerful signals and help you identify overbought and oversold stocks.
Here are some popular momentum oscillators
In a nutshell
When you trade with limited capital and can buy only a certain number of stocks, trend analysis becomes extremely crucial. Comprehensive trend analysis can help you improve your chances of striking profitable trades and earn superior returns on your investments.
Disclaimer:
The blog is for information purposes only and anything mentioned herein shouldn’t be construed as a fundamental reason to buy/hold/sell any stock. Furthermore, the information provided in the blog and observations made there shouldn’t be treated as the extension of recommendations made on the other properties of Ventura Securities. If you follow any research recommendations made by our fundamental or technical experts, you should also read associated risk factors and disclaimers.
We strongly suggest you consult your financial advisor before taking any decision pertaining to your finances.
We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to the blog article hereby solemnly declare & disclose that:
We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in the securities of the company. We do not have any directorships or other material relationships with the company.
We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.
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