Forum Archive Index - June 2001
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[sharechat] LEARNING TO INVEST >>>>>> TRENDS
A trend is simply the direction of the market, the way it is moving. Up,
down or sideways. As we all know, markets do not generally move in a straight
line, but progress by making a series of zig-zags. It is, therefore, the
direction of these peaks and troughs that constitute market trend. Thus an
uptrend is a succession of higher highs and higher lows. A
downtrend is a succession of lower highs and lower lows. A flat, sideways
market is usually described as trendless. There are many old sayings like
"always trade with the trend", "never buck the trend" and "the trend is your
friend". We want to monitor the market action, with the object of participating
in uptrends whenever possible.
Monitoring the market for evidence of any trends can be done in many ways.
You could have all the price data in a spreadsheet, and examine the columns of
figures for evidence of any sustained trends. Possible, but very difficult.
Trends are much more evident if the data is presented in the form of a graph. A
simple visual inspection will reveal them. Graphs also give some idea of the
rate of change of prices - very difficult to see from a column of figures.
Graphs make it very easy to see if peaks and troughs are rising or falling, if
the trend is up
Trends start, continue for an indeterminate period of time, and end. Some
trends are sustained for years, but nothing goes on forever, so we need to
define the point at which we will consider the trend is over. The end of an
uptrend could be defined as when we get a lower low after a lower high (a new
downtrend). We could use a very complex mathematical construct such as
polarized fractal efficiency. We could use a trendline break. I favour
trendlines because of their simplicity, ease of use, and the fact that they are
not subjective, and can not be fudged.
A stocks price movement is simply the process of the markets continual
re-assessment of its true worth. It would have been very obvious to any trader
using fundamental analysis that the issue price of Telstra was way below its
true value. Over the course of about 15 months, the market price of TLS rose
steadily but rapidly at an average rate of about 8% per month. This very high
rate was sustained (or exceeded) for month after month after month. This was
not random movement - the stock was steadily, rapidly and inexorably climbing,
as it was continually re-rated by the market. It looked as though it was going
to the moon, but no trend lasts forever. Quite suddenly (at 920) it hit strong
resistance (selling pressure) and fell. This was the maximum value the market
was prepared to assign to this stock, at this time. The theoretical fundamental
value of TLS at this point was merely academic. (Fairly valued? Over valued?
Still Undervalued?) The market had spoken. 920 and not a cent more. The price
continued to fall, until, at 730 it found support. Buyers appeared in
significant strength, and the price rose again. These support and resistance
levels defined what is known as a Trading Range, and price action oscillated
between these 2 limits for about 15 months. This was followed by a downtrend,
not shown on the chart.
The basic trendline is one of the simplest technical tools used by the
chartist, but is one of the most valuable. In order to plot a trendline we need
to have a trend. For an Uptrend this is defined as a series of higher highs and
higher lows. A rising trendline is plotted by linking successive swing lows
with a straight line. (Falling trendlines are drawn through successive swing
highs). As soon as we have two clear swing lows, with the second higher than
the first, we can draw in a tentative trendline. For a trendline to be
considered valid, it needs to be confirmed by prices "respecting" it by
bouncing off it at a third point. In the TLS bar chart below, this happened mid
October, 1998. We now had a valid, confirmed trendline representing the
steadily rising support for TLS, and the average rate at which it was rising.
We know our exit strategy. We will sell when the price breaks through the
confirmed trendline by closing beneath it. We do not know when this will be. We
do not know at what level it will be. But we do know that one day it will
happen, and we are out at that point. Just over 6 months later, the trendline
support is broken and we sell at 780.
The chart below has a logarithmic price scale. This should always be used
when the price action covers a very large range, so that price movements of a
given percentage are the same relative size at both ends of the scale.
This post was prepared by order of Gerry Stolwyk, for incorporation in the
"Learning to Invest" series.
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