A key to weathering – and potentially profiting from – a market correction is planning and implementation.
Spotting the Trend Can Keep Your Trading on Track
The trend has long been considered a key building block on which much of technical analysis rests, but it’s one that many traders ignore. Instead, they’re quick to jump into a trade based on indicator readings or chart patterns without much regard to the bigger picture.
But context is everything, and looking at a security’s long-term position can provide a different perspective. For example, what might appear to be a constructive chart pattern based on very recent price action may actually be a pause or consolidation within a powerful longer-term down trend.
How to spot trends
- Direction. Trend analysis begins with the question: Is the stock moving from the lower left corner of the chart to the upper right corner of the chart? If so, there is an obvious uptrend in force. If the stock is moving from the upper left corner of the chart to the lower right corner, it’s easy to see a downtrend as the dominant feature. (See the chart below).
- Progression. Another basic technique is to look for a progression of peaks and troughs where, for example, a series of higher highs and higher lows will confirm a directional uptrend (the opposite is true for a downtrend).
In reality, there are several trends in force at any one time: the long-term trend, the intermediate-term trend and the short-term trend. These different trends will not always be in agreement with each other, so traders must determine which trend will be the focus of their activity.
Traders should recognize that the short-term trend will often be influenced by day-to-day news, so focusing on the longer-term trends might be prudent.
Technical analysis tools for spotting trends
Other than just price alone, moving averages can be an effective technical tool for determining trend direction.
Moving averages can also help identify the strength of a trend. Steeply sloping moving averages can mean that there is momentum in the price move. Flattening moving averages can suggest a move that is losing momentum or the formation of a trading range.
Traders also can identify the simple trend line that connects points on the price chart to help determine a trend. For example, an uptrend line connects a series of higher lows on the charts, and the slope of that line becomes a point of reference for determining direction as well as providing a logical point of support.
To cover more ground, the Recognia® screening tools, which can be found on ScottradeELITE®, allow the user to select those stocks with a bullish pattern indicated by the price moving upward. This can be an effective way to begin to look for opportunities that would meet the basic requirement of trending market action
While these strategies can be effective, they’re not foolproof. Any trade involves risk.
Why is trading with the trend important?
If you are in sync with the current direction of the momentum, you might be able to make more informed decisions. By understanding the trend, you might be able to position yourself to take advantage of a pause or pullback in price movement, however doing so doesn’t guarantee a profit.
Trading with the trend can be much more forgiving than trading against it. For example, a poor entry will be less of a factor when a trend reasserts itself. Trading losses often occur when the trader is positioned against the main trend and is fighting market momentum.
Question: How to you use trend analysis in your trading?
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