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Trend identification can be called the keystone of technical analysis.
The price typically moves in a wave like motion forming a series of peaks and troughs. The direction in which these peaks and troughs are moving is called the trend.
In an up trend, we have a series of higher peaks and higher troughs.
In a downtrend, we can see successive lower peaks and troughs.
When the peaks and bottoms move horizontally we call it the sideways trend.
The weekly chart of Akzo Nobel is a classic example of an up trend.
Note how the stock is moving higher since 2001 in a series of higher peaks and troughs. Downtrends are not hard to come by in this market. The stock of Reliance Communication is in a downtrend since January 2008.
A stock chart that resembles a roller-coaster ride is typically in a sideways trend.
Sintex Industries is moving between Rs 60 and Rs 250 since 2006. Such sharp price swings are common when stocks enter a sideways or consolidation phase.
Trend identification is done with the help of trend lines. Constructing a trend line is fairly simple.
When the stock is in an up trend, the trend line is constructed by joining the troughs formed during the up trend.
Conversely, a down trend line is formed by connecting the peaks formed during the downtrend.
Trading with trend line is also rather straightforward and it is one of the first tools that a technical analyst learns to use. A buy signal is generated when the stock price moves above the down trend line. A sell signal would be generated when the stock price moves below the up trend line.
Let us elucidate with an example. Andhra Bank has been in a downtrend ever since it peaked at Rs 190 in December 2010.
The next significant peak was formed at Rs 159 in April 2011. We should join these two peaks with the help of a trend line.
This downward sloping trend line was breached in February this year thus signalling a trend reversal.
It is often observed that the trend in a stock can vary across time frames.
If we revert to Andhra Bank, the long-term trend in this stock is down, the medium-term trend is up and the short-term trend is sideways.
It would be safer to trade long in stocks in which the trend is bullish across all the time frame such as Ambuja Cement.
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