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4. Technical Analysis: The Use Of Trend
The idea of a trend is perhaps the most important concept in technical analysis. The meaning in
finance isnt all that di erent from the general definition of the term a trend is really nothing more
than the general direction in which a security or market is headed.
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There are a lot of ups and downs in this chart, but there isnt a clear definition of which direction the
stock is headed.
A Formal Definition
Trends arent always easy to spot because prices almost never move in straight lines. Rather, prices
tend to move in a series of highs and lows over time. In technical analysis, it is the overall direction of
these highs and lows that constitute a trend. An uptrend is classified as a series of higher highs and
higher lows, while a downtrend consists of lower lows and lower highs.
Sideways or horizontal trends occur when there is little movement up or down in the peaks and
troughs of a trend. If you want to get technical, you might even say that a sideways trend is actually
the absence of any well-defined trend in either direction. (For more insight, see Peak-And-Trough
Analysis).
Analysis).
Trend Lengths
In addition to their direction, trends can be classified in terms of their length. Most traders consider
trends short-term, intermediate-term, or long-term. Long-term trends occur over a timeframe of
longer than one year; intermediate-term trends occur over one to three months; and, short-term
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trends occur over less than one month.
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Trends are also embedded within one another. For example, Figure 1 above is an example of a long-
term five-year trend and Figure 2 is a two-month subset of that trend. In other words, long-term
trends consist of a series of intermediate-term trends which consist of a series of short-term trends.
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Long-term uptrends may have several short- and intermediate-term downtrends along the way.
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Heres an example of how these trend lengths look in practice:
Trendlines
A trendline is a simple charting technique whereby a line is added to a chart to represent the trend in
a market or stock. Drawing a trendline is as simple as drawing a straight line that connects lower
lows or higher highs to show the general trend direction. These lines are used to cut through the
noise and show where the price is headed, as well as identify areas of support and resistance
resistance..
Support levels are where the price rebounds higher multiple times, whereas resistance levels are
where prices rebound lower multiple times. The strength of support and resistance levels are
determined by the number of rebounds from the trendline. (To read more, see Support & Resistance
Basics and Support And Resistance Zones Part 1 and Part 2).2).
Figure 5 shows an example of a downtrend trendline where the stock price experiences resistance, as
Figure
well as an uptrend trendline where the stock price experiences support.
Channels
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A channel consists of two trendlines that act as strong areas of support and resistance with the price
bouncing around between them. The upper trendline consists of a series of highs, while the lower
trendline consists of a series of lows. A channel can slope upward
upward,, downward
downward,, or sideways
sideways,, but
regardless of the direction, the interpretation is always the same. Traders expect the price to trade
between the support and resistance trendlines until it breaks out beyond one of the two levels, in
which case traders can expect a sharp move in the direction of the breakout. Along with clearly
displaying the trend, channels are used to illustrate important areas of support and resistance for
the stock price.
Figure 6 illustrates a sideways channel where the upper trendline connects a series of highs and the
lower trendline connects a series of lows. When the price breaks out from the upper trendline, the
upper trendline becomes a new support level as the stock moves higher.
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