A trend defines a direction in market prices. When we refer to a trend, we mean a directional trend (formed by rising or declining prices), from which a trader can generate a profit, if using an appropriate trend-following method. A rising trend (uptrend) is formed, when prices reach higher peaks and higher troughs.
A decreasing trend (downtrend) is formed, when prices reach lower peaks and lower troughs.
A sideways trend (flat trend) occurs, when prices tend to trade in a specific range without demonstrating a significant upward or downward movement, they move up and down, but remain at approximately the same level. This configuration occurs after a larger trend has reached a temporary halt. A flat trend is also called a consolidation or congestion area.
In strategic terms, an investor, who relies on technical analysis must decide: first, when to enter a position, and second, when to exit the market. Exiting a position, however, is comprised by two decisions. The investor must decide when to exit a position in order to lock-in a profit, when prices move in the expected direction.
And also, he/she must decide when to exit a position at a loss, when prices move in the opposite direction from what was anticipated. Every trader needs to be aware that the actual trend might differ from what he/she expected. Therefore, deciding at what price level to sell and reduce losses before entering into a position is a way to protect against huge losses.
How can we identify a trend?
- Use moving averages to smooth out shorter trends within the trend of interest and identify the longer-term trends.
- Another method to identify trends is to examine a graph of prices, looking for extreme points (peaks and bottoms), which are separated by certain periods of time, and then, draw lines between these points.
Trend lines are used to determine limits to price action, which, if broken, can signal that the trend may be reversing.