The basics of price trends

Decades of price charts have demonstrated one basic truth - prices move in trends. A trend indicates that there exists an inequality between the forces of supply and demand:

When the supply of a stock or commodity is greater than the demand for it, the trend will be down since there are more sellers than buyers;
When demand exceeds supply, the trend will be up as the more numerous buyers bid up the price; and
if the forces of supply and demand are nearly equal, the market will move sideways - in what is called a trading range.

A trend may thus be considered as a phase in a market's movement when prices are going in a particular direction, notwithstanding some smaller counter moves in the opposite direction.

Those who don't use price charts can get an indication of the general direction of how prices are moving by regularly following the financial media.

But a user of price charts will be able to get a better idea even by merely visually reviewing the longer time-frame price charts, such as a weekly or a monthly chart.

Types of Trends

Broadly, there may be two types of trends:

A rising trend, or an up trend; and
A falling trend, or a down trend.

A rising trend, or up trend, is said to exist when prices are generally rising, notwithstanding small intermittent falls (corrections).

To be more specific, when prices make higher highs and higher lows it is a case of rising trend. This must be considered as a basic and necessary condition of an up trend (see Chart 1).

Chart 1: Example of an up trend. Points H1, H2, H3 and H4 show higher highs while points L1, L2, L3 and L4 are higher lows.

A falling trend, or a down trend, on the other hand is said to exist when prices are generally falling notwithstanding small up moves (corrections).

More precisely, when prices make lower highs and lower lows it is a case of falling trend. This must be considered as a basic and necessary condition of a down trend (see Chart 2).

Chart 2: Example of a down trend. Points L1, L2, L3 and L4 show the lower lows while points H1, H2, H3 and H4 indicate lower highs.

Further, during a rising or a falling trend there may be periods when prices move in a narrow range. On the charts, this would appear as if the price is moving horizontally, i.e. sideways. Such a period is said to be a flat or sideways trend. It may be noted that a sideways trend is not a trend in the real sense of the word, but only a period of non-directional price stagnation also called a trading market as distinct from a trending market.

What's a Correction?

One important point that needs to be made here is that the term correction does not necessarily mean falling prices. It simply means a smaller price move which is counter, i.e. opposite to the prevailing trend.

Trend Reversal

When the basic and necessary condition defining a trend is invalidated, it is a signal of a trend reversal.

Thus:

When after consistently making higher highs and higher lows in an ongoing rising trend, the market index or a stock as the case may be, makes a lower high and lower low formation, the up trend is said to have reversed direction into a down trend.
Conversely, when after consistently making lower highs and lower lows in an ongoing falling trend, the market or a stock makes a higher high and higher low formation, the downtrend is said to have reversed direction to up. (see Chart 3)

Chart 3: Example of a trend reversal.
The latter part of the above chart is a continuation of Chart 2, which showed the previous down trend in the same security. Subsequently, the price broke above the most recent high (marked H4) which suggested that the down trend had reversed.

Knowledge of both the current trend and trend reversal is important for traders and investors for making appropriate trading and investment decisions. Thus:

In a rising trend, a trader's strategy would be to buy stocks on any price falls (corrections), and then wait for price to resume its up trend.
Conversely, when the main trend is down, a trader's strategy would be to exit stocks on price rises (corrections), and then wait for lower prices to re-enter the market.

Check out more Vision Book stories

[Excerpt from How to Profit from Technical Analysis: A Beginner's Guide by Rajiv D. Khatlawala. Published by Vision Books.]

Available at: