The Power of Stock Price Trends
If you look at prices on a stock chart, they may seem to move randomly. In fact, prices do move randomly. But they often exhibit repeatable pattern that can be exploited. When we can identify these patterns, we can anticipate that direction of prices with a high degree of probability. So prices of stocks tend to move in trends like the way water moves in the current.
Truth of the trend
One of the most important principles in trading and investing is that an established trend in price is statistically more likely to continue in the direction of the trend than it is to reverse. So once you are able to identify a trend, whether it is an uptrend or a downtrend, and you can identify when the trend reverses, you can profit immensely from it. In fact that is how lots of money is made in the markets.
Essentially there are three kinds of trends that a price can move into. I will explain each kind of trends and the strategies that you can apply.
There are times when the market is in an expansionary phase when there is growth in the economy or in the company and the market is optimistic and bullish. So the price will exhibit an uptrend pattern. On an uptrend you will notice that the prices still fall. But every time they fall, they go higher. In other words, the price makes higher highs and higher lows. In fact the definition of an uptrend would be price making higher highs and higher lows. So when the stocks are on an uptrend, the probability is that prices will continue moving higher and higher over time.
Strategy: Buy the stock or stay in the long position where is on an uptrend. The term ‘going long’ means buying in anticipation of the price moving up. The best time to go long or to buy the stock on an uptrend is when the price makes a temporary fall or ‘dip’ on the uptrend. That is because we always want to buy as low as we can in order to make more profits when it moves higher. We should not buy the high of the uptrend because price tends to dip down before moving higher.
The phrase ‘Never Catch A Falling Knife’ suggest that we must never assume price is at its lowest point of the dip. It would be unwise to buy at an assumption as it could continue to go lower and begin its downtrend. We must wait for a confirmation signal before buying. A support line or Moving Averages such as 50MA, 150MA and 200MA can be used as a confirmation signal.
The opposite of an uptrend is a downtrend. There are times where the market will reverse into a downtrend. During times of crisis, uncertainty and recessions the market goes into a downtrend phase as it is pessimistic or bearish.
On a downtrend, the prices can still move up. But every time the price goes up, it goes lower. In a nutshell, price makes lower highs, and lower lows. Here is one of the most important rules: you never ever buy or hold a stock when is on a downtrend. That is because on a downtrend, the price tends to continue going lower. So no matter how cheap the stock is, never buy it on a downtrend because cheap can get cheaper, and low can get even lower. You never swim against the current as the current will pull you down and drown. No matter how good the company is, don’t buy the stock on a downtrend. Always wait for a reversal of trend.
In fact on a downtrend, you want to sell the stock, or to do a short sell so that you profit as the price moves down.
Strategy: The best time to sell the stock on a downtrend is when the price makes a temporary high when it rallies. Similar to the strategy we use for an uptrend, we have to wait for a confirmation signal before we short sell. As the price rally and hits a resistance, you sell only when it bounces back down.
Stocks can go through a consolidation phase. Normally when a stock goes on an uptrend, it will go through a consolidation for a while before breaking out to continue the uptrend or it may reverse and break into a downtrend. To identify a consolidation phase, visible resistance and support can be seen using technical analysis.
A general rule of thumb is that you don’t want to buy or sell when the price is in a consolidation pattern because it can get stuck there for weeks or months or years. You only want to buy when the price breaks above the resistance or go short when the price breaks below the support.
In conclusion, you should always look for stocks with repeatable patterns to make money on trends. I have created a video tutorial below for you to enhance your learning. The video has also included the different period of trends such as a short term trend, medium term trend and long term trend, as well as the different strategies you can use to invest and trade on a different timeframe.
Stock investment & trading strategies: The Power of Trends
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