The term trend is ubiquitous in technical analysis literature. Clichés abound like ‘Ignore the trend at your own peril’; ’The trend is your greatest ally’ and so on. The primary objective of technical analysts is to identify the trend and to stay on the right side of it. Entry and exit points in trades are made to coincide with trend reversal points.
What is a trend? 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 monthly chart of Sensex since 2003 is the classic example of an up trend. Down trends abound in the current market. Movement of Reliance Natural Resources since January 9 is the typical example of a downtrend. Satyam Computers is going nowhere in particular since early January 2007. That is a sideways trend.
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. While this method of drawing the trend-line can be used on charts drawn on arithmetic scale, semi-log trend lines ought to be drawn if the chart is plotted on the semi-log scale.
Plotting the trend line is a skill that gets honed only with practise. 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. However, it prudent to combine the trend line with other technical tools such as oscillators to corroborate the signals.
The weekly chart of Thermax has been in an up trend since 2003. Though the trend line was tested briefly in June 2006 and March 2007, it has been penetrated conclusively only this February.
TCS is the typical example of a stock in a downtrend. The stock can be purchased once it closes firmly above the trend line that is positioned at Rs 1,050