Foundations: Anatomy of a Trend

We covered in last Thursday’s blog that Technical Analysis focuses on the price action of a stock and how the current and historical price points can anticipate future price direction and activity. Thus, by studying the candlestick chart of a particular company, we can, in essence, make an educated guess on the stock’s future behavior. As we look at a candlestick chart, we tend to first look globally before going in for a more granular examination, and by globally, we mean we are scanning for trends. Now, we introduced you to the idea of trends in our Foundations level 1 class blog, which you can read here if you wish; and today, we are going to dive deeper into this topic for a more comprehensive understanding of what makes a trend.

Composition of a Trend

Candlestick trends can move in three different directions: up, down, and sideways, which brings us to the question of what components compromise a trend, and how can we identify them? Regardless of the direction of the trend, we can recognize them by their peaks and troughs. These points can be referred to as swing points as they are points at which a stock pivots in price from one direction to the opposite direction.

Peaks and Troughs of a Trend​​​​

A peak is defined as the point at which a stock crests in price. In an upward trend, the peaks of the trend will be higher and higher in price as they occur and in a downward trend, the peaks of a trend will be lower and lower in price. Lastly, in a sideways trend, the peaks will remain at about the same price point.

In contrast to a peak, a trough is defined as the point at which a stock bottoms in price. In an upward trend, the troughs or low points of the trend will be higher and higher in price; in a downward trend, the troughs of a trend will be lower and lower in price, and in a sideways trend, the troughs will remain at about the same price point. It is when the peaks and troughs of a trend continue to move in one direction that we can spot and clearly identify a trend in progress.

Usually, it takes three points of connectivity to confirm a sustainable trend. In the image above of Take Two Interactive Software candlestick chart, we have marked the peaks of the uptrend and the channel in which the trend was moving. The first indicator of the uptrend in the price of the stock was the crossing of the Exponential Moving Averages at the end of April, which was followed by a peak a few days later. Both markers are reliable indicators of an upwards shift in price. However, it took two more peaks to solidify this stock was in a sustainable upward trend. It should be noted, yes, you could have entered a bullish trade when the EMAs crossed, but if you were waiting for solid confirmation, you would have entered a long trade in the first part of June.

In closing, being able to locate and confirm trends are a great way to consistently execute trades, which will generate profits from trading the identified trends. The best way to do that is to get out there and start looking. As always, we strongly recommend doing this via virtual or paper trading, which you can do with TradingView.

Thank you for reading and join us next week, where we dive into class 3 of the Foundations of Stocks and Options Level 2.