What Is a Trending Market?
A price series that continually closes either higher or lower (on average over a defined number of periods) is said to be trending. An upward trending market is one that may fluctuate up and down but on average tends to close periodically higher. A downward trending market ends periodically lower regardless of interim moves. Securities in any asset class tend to show trending behavior of some kind.
- Trending markets drift higher or lower in ways that may or may not be explainable.
- Even random markets trend, but all trending asset prices represent trading and investing opportunities.
- Technical analysts study trends to identify when a trend may end or change.
Understanding Trending Markets
The Efficient Market Hypothesis (EMH) posits that markets are not predictable through prior information such as price or earnings data. This seems to imply that prices should exhibit a random walk over time. Trends would seem to be an anomaly in this model but in fact, they are not. Since random data in any series tends to trend more often than not, trends are commonplace in any asset class.
A trending market can provide multiple trading opportunities for investors, traders, and technical analysts. Technical analysts will chart the price pattern of a security or market index to identify trending directions for placing investment trades. Investors may also follow the trending direction of an index that serves as a benchmark for a specific security. These trending market lines can serve as an overlay to a security price chart which can help to form an additional indicator for market trends.
Trending markets are of primary interest in technical analysis. Technical analysts believe that trending markets occur with some degree of regularity and predictability. The ability to correctly discern these trends can have a substantial impact on investment returns.
Identifying a Trending Market
Traders use various patterns and trend lines to identify trending market directions and trading signals for a single security. A trending market can be classified as such for either the short-, mid- or long-term. Several trading channels can be drawn to follow a security trend. Some of the most common trading channels include the following:
- Ascending: In an ascending channel, a security is showing a bullish trend. This is represented by two positive sloping trend lines drawn above a security’s peaks and troughs.
- Descending: In a descending channel, a security is showing a bearish trend. This is represented by two negative sloping lines drawn above and below the candlestick pattern.
- Sideways: A security or market index can also be showing a sideways channel. This trend will be flat. In a sideways channel, two zero-sloping trend lines will be drawn from a security’s peaks and troughs.
Assuming the price of a security is expected to remain within its trended pattern, traders can use resistance and support lines to indicate buy and sell signals. Thus, when a price reaches a resistance line, traders can be expected to initiate sell orders to benefit from a potential reversal to a bearish trend. Adversely, when a price reaches support lines, buy orders would typically be initiated to profit from a potential reversal to a bullish trend.
One caveat for standard trading channels is that they do not fully encompass price movement through reversals and changing trends over time. This can lead to the use of wedge price patterns which are ascending or descending channels with non-parallel trend lines pointing to a condition in the near future where a potential trend reversal can occur.
Envelope channels can also be used to broaden the range of price levels and provide for a single channel used over a long period of time. Envelope channels use non-linear trend lines drawn at resistance and support levels to create a moving channel over an extended period of time that can encompass both bullish and bearish trends.