Trends and Trendlines

If you want to be a successful trader it is imperative that you understand the concept of a trend and how to correctly utilize trendlines.   In all liquid markets prices move in trends, regardless of whether we're talking about stocks, commodities, real estate, or even the price of milk.

Prices are always doing one of three things.  They are either going up, going down, or staying they same.  In uptrends, the forces of demand are in control and the buyers overpower the sellers.  In downtrends, the forces of supply are in control and the sellers overpower the buyers.  When prices are staying the same the forces of supply and demand are equal.  All of these dynamics can be illustrated with properly drawn trendlines.

There is nothing mysterious about trendlines  It's really just logic and common sense.  If used correctly, trendlines should simply be graphical representations of the supply and demand dynamics that are occurring in markets.  It makes me laugh when people say that technical analysis is voodoo.  I suppose they say this because most of the technicians that I see in the media are not very good, and some other aspects of so-called technical analysis are downright ludicrous.  But prices do in fact move in trends, regardless of what market we are talking about, and if you can identify them it will benefit your trading and investing because it will help you understand when it is the most optimal time to buy or sell.

For an example of a trend, if the price of milk goes from $3 to $4 dollars over the period of a few weeks, which price sequence do you think is more likely to occur?  $3.00, 3.10, 3.40, 3.60, 3.80, then 4.00...or $3.00, 4.80, 2.10, 1.75, 3,10, 3.70, 3.20 and then 4.00?  In normal markets clearly it is the first one.  So right at your local grocery store there is proof that prices move in trends, and if you can recognize them it can lead to much lower risk trades than getting ideas from some moron in a chat room or on CNBC.

Drawing trendlines is an art and not a science. The tricky thing is understanding that there are trends within trends, and they are fractal in nature.  That means that there are trends within trends and trends within those trends and so on.  There are trends that last for decades or even longer and there are trends that last for minutes, hours, days, weeks, months and years.  The trendlines that illustrate them are neither magical nor mysterious and they should simply be viewed as what they are…a simple visual picture of the supply and demand dynamics that are occuring.  

If drawn correctly, a trendline break will show a change in the supply and demand dynamics that are occurring in a market.  For example, in an uptrend the forces of demand are in control.  When the uptrend line breaks, this shows that the forces of supply have overpowered, or at least become equalized with the forces of demand.  During a downtrend, the forces of supply are in control.  When the downtrend line breaks, it means that the forces of demand are overpowering or at least becoming equal to the forces of supply.

Let's take a look at this chart of GS...Goldmine Sachs... from March through the end of June of 2018.  You can clearly see here how trends are fractal in nature.    We can see that in the longer period of time, from March through June, the aggregate forces of supply were in control and they have driven the stock lower.  This is illustrated by the long blue arrow.  

We can also see that within this longer trend, there are multiple shorter-term trends.  You can see that in the two week periods in the beginning of March, April, May and again in June the demand side was in control of the market and this drove the stock higher.  This is shown by the red arrows.  In the last two weeks of those months the supply side was in control and they drove the stock lower. This is illustrated by the black arrows.  We can also see that the four trend breaks, which are illustrated with green circles, are the times when the forces of supply became equal to and then overpowered the forces of demand.

 

 

Utilizing trendlines is a good way to help take the emotion out of your trading, which is what you should be trying to do.  If you are interested in buying something that has been going down for awhile and you can draw a clear downtrend line, wait until it breaks before you buy it.  You wont get it at the exact bottom, but the risk reward dynamics will be much better than just trying to guess where the bottom is...which is exactly what you are doing if you don't have a clear understanding of this.  Of course, the opposite is true if you are making a sale.

If you happen to have the unfortunate experience of running into an academic or someone who actually believes in Efficient Market Theory at a cocktail party anytime soon, you can stump them with this question.  Ask them why markets trend lower faster than they trend higher?  If markets were truly efficient they would move at the same speed in either direction.

The reason why this occurs is because when markets are rising, they are rising on hope.  When they are going down they are selling off on fear.  Fear is a more powerful emotion than hope and this causes people to be much more aggressive when they sell than when they buy.