Technical Analysis: The trend and common beliefs
As I begin my journey in studying technical analysis I feel one way to get it solidified in my brain is to write about it, so here goes nothing. In this short article I’ll be going through the basics of technical analysis:
What a trend is and why it’s important.
Identifying trends and the different types
The fractal nature of trends
Common beliefs of technical analysts
Disclaimer
This content is for informational purposes only and should not be construed as legal, tax, investment, financial, or other advice.
What is a trend and why is there so much fuss about it?
A trend can either be upwards, downwards or flat(some say sideways). What this means is prices are generally either headed up, down or are still deciding which way to go, so do neither. In technical analysis speak, we’d define an uptrend as prices making higher peaks (highs) and higher troughs (lows). A downtrend is the opposite, where prices are making lower peaks and lower troughs. A flat trend is when prices are generally trading in a range and not moving either upwards or downwards.
So now we know what a trend is, why is it so important? If you’re anything like me and hope one day to be able to make money in the markets using technical analysis an important part of being able to do that is identifying an uptrend, downtrend or flat trend at the very start of their formation. This is how the technical investor makes money, by identifying trends and capitalising on them. The technical investor can use the identification of a trend to decide when to open a position, estimate how long to hold it and when to exit out of the position. As simple as it may sound, this is very difficult and has a lot of risks, so the technical investor has to make sure to understand the risks and plan for unintended circumstances where their analysis of the trend may not be correct.
Identifying trends and the different types
There are many different ways to identify trends; some connect the peaks/troughs and draw a line to show the trend (pictured in image below), whilst others connect a trough to a peak (in the case of an uptrend) and draw the trend line through the price action. And of course, there are the numbers guys who may try using a linear regression line to fit the data; the problem with this, is that trend identification can only be done in retrospect. Meaning that we need all the price information in order to do the linear regression and identify the trend. This of course defeats the purpose of identifying the trend as early as possible so is not the best method for identifying trends. However, there is a multitude of tools and methods that can be used to identify trends early, like chart patterns which have shown to have statistically significant results. I will touch on these and other methods in future articles.
Technical analysts have divided the trends into various categories, the main ones being the primary trend (measured in months or years), secondary trend (measured in weeks or months), minor trend (measured in days) and intraday trend (measured in minutes or hours).
What is the fractal nature of trends?
Despite the definitions of trend lengths above, there are many more trend lengths, it’s really an unlimited amount of time a trend can last. But what is interesting about all these different trends is that they can be identified using the same tools and methods, regardless of the time horizon. So the fractal nature of trends is the ability for them to act the same in different periods.
Some beliefs of technical analysts
- Price is determined by the interaction of supply and demand.
- Price discounts everything; information released about the security, people’s feelings, biases and expectations for the security.
- Prices are nonrandom.
- History will repeat itself; people are likely to do what they’ve always done in similar circumstances.
- Like trend lines, patterns are fractal thus pattern analysis is universal and independent of time
Conclusion
The trend is the direction in which price is moving, identified through various methods including drawing trend lines. Using these methods, technical analysts hope to identify a trend as early as possible in order to try and profit from the information. Technical analysts have to choose the trend type they’re interested in (primary, secondary, minor or intraday) in order for them to properly analyse the market and identify the trend or changing trend. However the same tools and methods can be used on all trend types, as they are all fractal in nature.
Technical analysis is a huge field of study and I will be documenting my learnings and failures with articles like these in the future.
