What are market trends and how do you analyse them?

Market trends are a cornerstone of most trading strategies, providing key entry and exit levels for positions. Learn about the types of market trends and how to analyse them.

What are market trends?

Market trends are the perceived direction of price movements over a given period. Markets can trend upward, downward or sideways, there just has to be a single prevailing direction.

Traders use trends to help make market movements more predictable. They can forecast and analyse price action based on historical data and trends, to try and understand whether particular patterns will re-emerge.

Types of market trends

There are a few ways of classifying the types of trends. The most common categories of trend are according to the direction of the price movement. These are:

• Uptrends – also known as rising trends – describe an increase in the price of a financial asset. They’re comprised of higher lows and higher highs, which ultimately create a bullish market
• Downtrends – also known as falling markets – describe a decrease in the price of a financial asset. Their structure is comprised of lower lows and lower highs, which creates a bearish market
• Sideways trends – also known as rangebound markets or consolidating markets. Here, an asset’s price is rising and falling between two levels, normally known support and resistance levels

However, it’s also common to see trends categorised by duration, such as:

• Major trends – which are the longest-term trends, lasting decades. A major trend can contain many other types of market movements, but the overall direction of the market remains the same
• Intermediate trends – these trends are ‘medium term’, and generally last one to three years. They’re what are commonly described as ‘bull’ and ‘bear’ runs. The market can fluctuate still, but there is a strong momentum in a single direction
• Minor trends – these trends are short-term movements that happen within the overarching longer trend. They are sudden changes in price that can last from just seconds to months. Minor trends are the result of sudden, breaking news or speculative trading

How to identify the trend of the market

To identify trends, traders will use a range of technical indicators that give insight into the direction and strength of price action. The most common indicators are for trend-trading strategies are:

• Moving Average Convergence Divergence (MACD)

  MACD finds the average price of a security over a specific time period. The indicator is made up of two lines. The first is the MACD line, which tracks the difference between two moving averages (MAs) of different durations – one shorter and one longer. The second line is the signal line, which is the moving average of the MACD line.

  The idea would be to ‘buy’ when the MACD rises above the signal line indicating that prices are rising, or ‘sell’ when the MACD falls below the signal line, indicating that prices are falling.
  
  
  

• Relative Strength Index (RSI)

  The RSI helps traders identify an asset’s momentum, as well as overbought and underbought signals. It shows the average profit and loss over a time period – normally 14 days – to determine whether the trend is positive or negative.

  The RSI is presented as a percentage that fluctuates from 0 to 100. When the indicator is above 70, the market would be overbought, and when its below 30, it would be oversold. These signals can help traders understand when a trend is reaching its end.
  
  
  

• Average Directional Index (ADX)
  The ADX is another momentum indicator, which helps traders understand the strength of a given price action, whether it’s moving upward or downward.
  
  The ADX is also presented as a percentage that ranges between 0 and 100. If the indicator has values between 25 and 100 it means that the trend taking place is strong, whereas if it falls below 25 it means it’s a weak trend. Once the market falls into the ‘weak’ momentum territory, the trend is coming to an end and is likely to reverse.

How to read trends in the stock market

To read trends in the stock market, it’s common to draw trend lines onto charts, which make it easier to understand the price action. Typically, the line must consist of at least three points to be considered a valid trend.

For example, uptrend lines are formed by joining two or more points on a chart and seeing a positive slope – the second point would be higher than the first and so on. If the market price stays above the trendline, it’s considered a strong trend, but a break below the trendline would be considered a bearish signal and indicate a potential reversal.

Downtrend lines, on the other hand, are formed when joining two more points on a chart result in a negative slope – the second point must be lower than the first and so on. If the price remains below the trendline, it’s a strong bearish trend, but once the market price breaks above the trendline, it’s a signal that the market will reverse.

Find out more about market trends

Our Academy has a range of resources on trends and how to trade them, as well as information on other trading strategies you could use.

You can also put what you’ve learned here into practise by opening a demo account. You’ll get access to the full range of trend indicators, including the MACD, RSI and ADX mentioned above.

If you’re ready to trade live markets, you can open a City Index account today.