Defining an Upward Trend
When a series forms that consists of two rising highs and two rising lows, it defines the uptrend. In the chart above, we see three rising lows and four rising highs, which is a very clear upward movement. Notice that the fifth high is lower than the fourth. Does this indicate that the uptrend has stopped? No, but it definitely gives cause to watch for changes.
Is there any importance to the time intervals between each high and low? No. The interval during which you trade is the determining factor. If you entered for several days as a swing trade, because you identified an uptrend on the daily chart (where each candle represents one day), that is the trend you need to “ride.” Long-term investors will generally ride trends based on weekly charts (where each candle represents one week), and intraday traders will identify and buy stocks over intraday trends based on five-minute candles.
When should you buy? If you're willing to take risks, buy after the first low. If you tend to be more cautious, and are willing to take a little less profit, buy after the second low. We will discuss this in detail later.
How Do you Know if You're in a Downtrend?
When a series forms of two dropping lows and two dropping highs, this defines a downtrend. In the chart above, we see a series of four dropping lows and three dropping highs: a very clear downtrend. Notice that the fifth low is higher than the fourth low. Does this mean that the downtrend has ended? No, but there is definitely room to suspect an upcoming change.
An Uptrend Example - Joy Global
Joy Global, Inc. (JOY) maintained an uptrend for almost three months, rising from a price of $44 to a peak of $64. Notice the four rising lows and the three rising highs before the stock changed direction, broke the previous low and dropped to a new low. If you had been holding the stock, where should your exit point have been? The correct answer is, the trend’s break point: that is, the drop below the last high’s low, beneath the $58 mark.
Until now, I've explained why it is so very important to trade with the trend, and so important to utilize it fully (Never forget that!). I also explained the three market trends, but I have not explained what these mean from the trader’s viewpoint.
Think for a moment: what does the trader always wish to know?
- A trader always wants to know the ratio of buyers to sellers – in other words, we want to know which of these two opposing groups is winning the endless tug-of-war.
- When buyers are winning, we see uptrends.
- When sellers are winning, we see downtrends.
- When there is a balance between buyers and sellers, the stock will move sideways, with slight upward and downward movements, but no real trend.
- What do professional traders do with this information?
- They will want to buy (long) when the buyers are winning: that is, when the stock is rising.
- They will want to sell short when the sellers are winning: that is, when the stock price is dropping.
- Sideways movement is dangerous. On the one hand, the stock is moving in a range that does not allow for making any profit. On the other hand, a small pull on the rope in favor of one of the sides can lead to losses.
This is why pro traders do not trade during sideways movement, but wait for a clear up or down trend. Avoiding any action is sometimes the best step to take. Over time, you'll discover that during sideways markets, you will do better when you do nothing! If market conditions do not allow joining a clear trend, don’t join. In other words, not joining means not losing money.
To learn more about the stock market and to begin your own journey toward financial independence, visit Meir Barak's site Tradenet and check out his book "The Market Whisperer."
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