Trends – Types and How to Identify Them

Now that you’ve built a foundational understanding of technical analysis, it’s time to dive deeper into one of its core elements: trends. In simple terms, a trend represents the general direction in which market prices are moving over a specific period. 

The word "trend" is used across various fields like fashion, economics, politics, and more. In stock market terms, however, a trend indicates a sustained direction of price movement, which can be upward, downward, or sideways. 

What Are Trends in Technical Analysis? 

Trends help traders and investors analyze price movements from the past with the objective of forecasting future market behavior. These trends are built on historical price data and are crucial for: 

• Gauging stock or market direction along with volume 

• Planning strategic entries and exits 

• Enhancing decision-making through trend confirmation 

Some classic adages in trading reinforce the importance of trends: 

• "The trend is your friend" 

• "Trade with the trend" 

Types of Trends 

As you have learned from Dow Theory, market trends come in three main types: 

1. Upward Trend (Bullish Trend) 

• Characterized by higher highs and higher lows 

• Indicates consistent ascending price movement 

• Often supported by growing volumes and investor optimism 

2. Downward Trend (Bearish Trend) 

• Marked by lower highs and lower lows 

• Represents a declining price trajectory 

• Signals negative sentiment or broader market weakness 

3. Flat or Horizontal Trend (Sideways Trend) 

• Price moves within a defined range, lacking a clear upward or downward direction 

• Typically seen during market indecision or consolidation phases 

These movements align with Dow Theory’s classification of primary, secondary, and minor trends: 

• Primary Trend: Long-term movement lasting from 1–3 years 

• Secondary Trend: Intermediate corrections that span 3 weeks to 3 months 

• Minor Trend: Short fluctuations lasting less than 3 weeks 

How Long Do Trends Last? 

A trend generally remains intact until a clear reversal takes place. Reversals can be: 

• Bullish Reversals: Occur at the end of a downtrend 

• Bearish Reversals: Happen at the peak of an uptrend 

Identifying these turning points is an art that comes with experience. Many times, distinguishing between a correction and a full-blown reversal can be tricky, which is why confirmation is key. 

How to Identify Trends 

According to economic principles, price direction is influenced by supply-demand forces, and volume often confirms the trend. Here’s how trends can be identified: 

1. Price Action 

• Higher highs and higher lows = Bullish trend 

• Lower highs and lower lows = Bearish trend 
  This method doesn’t rely on indicators and is purely based on price movement. 

2. Simple Moving Average (SMA) 

An SMA calculates the average closing price over a specific period and plots it as a line: 

• Upward-sloping SMA → Bullish 

• Downward-sloping SMA → Bearish 

Popular SMA settings: 

• 200-bar: Long-term trends 

• 100-bar & 50-bar: Medium- and short-term trends 

• 7, 9, or 14-bar: Intraday and quick trades 

When prices close above the SMA after a decline, it can signal a potential rally. A close below after a rally may hint at a downtrend. 

3. Exponential Moving Average (EMA) 

Similar to SMA, the EMA gives more weight to recent price data, making it more responsive. EMAs are excellent for: 

• Spotting short-term trends 

• Identifying support and resistance zones 

• Tracking trend continuation or reversal 

The slope of the EMA still dictates the trend direction, just like SMA. 

4. Moving Average Crossovers 

Using two or more moving averages gives clearer signals: 

• Bullish Crossover: A faster MA (e.g., 50-bar) crossing above a slower MA (e.g., 200-bar) 

• Bearish Crossover: A faster MA crossing below the slower one 

Crossovers can be done using SMAs or EMAs, and they're more reliable than using a single moving average. 

Long-term crossover of moving average 

Short-term crossover of moving average 

5. Moving Average Convergence Divergence (MACD) 

The MACD is one of the most popular momentum indicators and works well in trending markets. 

• Uses the 12-bar and 26-bar EMAs to create the MACD line 

• The 9-bar EMA acts as a signal line 

• A histogram shows the difference between MACD and the signal line 

Key MACD Signals: 

• MACD above zero = Uptrend 

• MACD below zero = Downtrend 

• MACD crossing above the signal line = Buy signal 

• MACD crossing below the signal line = Sell signal 

Unlike moving averages, the MACD is plotted separately and acts as an oscillator rather than an overlay on the price chart. 

Conclusion 

Understanding and identifying market trends is essential for successful trading. While historical prices provide a base, it’s important to remember that past performance isn’t a guarantee of future results.