The most famous saying in the world of trading is: "The Trend is your friend... until it ends." But what exactly is a trend? In the simplest terms, a trend is the general direction in which a market or the price of an asset is moving.
As we learned in Module 1, prices do not move in straight lines. They move in a series of "waves." Imagine a river—individual ripples might flow in any direction, but the massive volume of water is moving toward the ocean. Your job as a technical trader is to identify that massive volume and "swim" in the same direction.
1. Dow Theory: The Origin of Trends
Charles Dow, the founder of the Wall Street Journal, established the foundation of modern trend analysis over 100 years ago. He realized that a trend is defined by the relationship between its "peaks" and "troughs."
Prices move in a zig-zag pattern. These zig-zags create two types of trends:
A. Uptrend (Bullish)
An uptrend is characterized by a series of Higher Highs (HH) and Higher Lows (HL). Even though the price occasionally falls (a pullback), each low point is higher than the previous low point.
Psychology: Buyers are so aggressive they step in to buy even at higher levels than before.
B. Downtrend (Bearish)
A downtrend is a series of Lower Highs (LH) and Lower Lows (LL). Each attempt by buyers to push the price up fails at a lower level than the previous attempt.
Psychology: Sellers are panicking and willing to sell at lower and lower prices.
C. Sideways / Range-bound
When the peaks and troughs are at roughly the same level, the market is in a "sideways" trend. This is also called Consolidation.
Psychology: Equilibrium. Neither bulls nor bears have the upper hand.
2. Support and Resistance: The Floor & Ceiling
Support and Resistance (S&R) are the "Invisible Barriers" on a chart. They are the levels where the price has historically struggled to move past.
The Role Reversal: One of the most important concepts in TA is that once a Resistance level is broken, it often becomes a Support level. Think of a man breaking through the ceiling of the first floor; that same ceiling now becomes the floor for him on the second floor.
3. Trendlines: The Diagonal Map
A trendline is a straight line that connects at least two (ideally three or more) price points. It acts as a diagonal support or resistance.
- Upward Trendline: Connect the Lows of an uptrend.
- Downward Trendline: Connect the Highs of a downtrend.
Rule of Validation: A trendline is only considered "Valid" once it has been touched at least 3 times. The more times it is touched without breaking, the stronger it becomes.
4. Identifying the Trend Reversal
How do we know when the "River" is changing direction? We look for a Change of Character (CHoCH).
- In an uptrend, if the price fails to make a new Higher High (indecision).
- Then, the price falls and breaks below the previous Higher Low.
- This "break of structure" is the signal that the trend has ended.
5. Multi-Timeframe Analysis
Remember the "Fractal" nature we discussed in Module 1. A stock might be in a **Downtrend** on a 15-minute chart (short term) but in a massive **Uptrend** on the Weekly chart (long term).
Strategy: Always trade in the direction of the higher timeframe trend. If the Weekly trend is up, only look for "Buy" opportunities on the daily chart. "Don't fight the big tide with a small boat."
Summary of Module 3
Trend analysis allows you to filter out the noise and focus on the primary market force.
- Use Dow Theory (HH/HL) to identify Bullish vs. Bearish phases.
- Identify Support and Resistance levels to find high-probability entry points.
- Draw Trendlines to see the path of least resistance.
- Wait for a Break of Structure before assuming a trend has reversed.
Now that we can identify the direction of the market, we need mathematical confirmation. How do we know if a trend is strong or weak? In the next module, we master **Technical Indicators (Moving Averages, RSI, etc.)**.