What is a Trend?
A trend is the general direction of a market or of the price of a security. In technical analysis, trends are identified by trendlines that connect a series of highs or lows. Most traders trade in the same direction as a trend, while contrarians seek to identify reversals. Trends can also apply to interest rates, bond yields, and other markets where they're characterized by a long-term movement in price or volume.
Trends and Technical Analysis
Technical analysis was founded on the premise that security prices trend over time, which makes identifying the trend one of the most important elements of the practice. Traders can identify the trend using various forms of technical analysis, including both trendlines and technical indicators. For example, trendlines might show the direction of a trend while the relative strength index (RSI) is designed to show the strength of a trend at any given point in time. Many traders live by the mantra, "the trend is your friend," with the exception of contrarians that seek to identify reversals.
Trends may also be used by investors focused on fundamental analysis, which looks at changes in the revenue, earnings, or other business metrics. For example, fundamental analysts may look for trends in earnings per share and revenue growth. If earnings have grown for the past four quarters, this represents a positive trend. However, if earnings have declined for the past four quarters, it represents a negative trend.
The most common way to identify trends is using trendlines, which connect a series of highs or lows. Uptrends connect a series of higher lows, creating a key support level for future price movements. Downtrends connect a series of lower highs, creating a key resistance level for future price movements. In addition to support and resistance, these trendlines show the overall direction of the trend.
The above example shows a bullish trendline along with an RSI reading that suggests a strong trend. As the trend began to lose strength, with the falling RSI reading, traders may have started to exit the stock. The breakdown from the bullish uptrend represented a potential change in the longer-term direction of the trend. Trend traders that were long in the security may have sold their shares and waited for a better entry point, while contrarian traders may have looked to initiate a long position after the stock had fallen and the RSI had bottomed out.