Learning to spot trends and act on them is often the secret to success in any trading markets. Many expert predictions and forecasts are little more than guesswork, and are of limited value when it comes to the nuts and bolts of actual trading.
As with any business decision, it’s important to look for signs of underlying strengths and weaknesses and use analysis based on real data as opposed to what you see in the regular news about commodity prices or the apparent state of the trading markets.
Spotting a genuine long-term trend requires the application of both science and instinct: a “gut feeling” based on knowledge and experience and backed up by rigorous analysis and a consistent strategy. Traders use charts to define trends as bullish- going up- or bearish- going down. Ideally you want to spot a trend ahead of everyone else, and jump on it. A trend’s use is to predict future prices if the trend continues. It is never a failsafe system though, and as always there are no guarantees.
The shape of things to come
It sounds simple, but trends are not as easy to spot as an outsider might assume. For example, prices will continue to rise and fall from one moment to the next, and a period of consistent falling prices can still be part of an overall upward trend if they recover to a higher point than they fell from. At a basic level, these overall trends can be discerned by imposing geometric shapes onto a graph, for instance a triangle, wedge, flag or pennant. These will show that an apparent drop in prices can still be part of an overall upward trend, or vice versa.
Many more complex tools are also used to predict trends, such as an alligator indicator or moving averages. You can find out more about the alligator indicator at ForexTraders, but keeping things simple for the moment it’s fair to say that charts and graphs are the most important ways of identifying a trend. Markets can go up, down or sideways, and a variety of charts are used to track these movements.
The bigger picture
Bar charts are the most popular method of analysing price shifts, but a simple line graph can provide a better indicator of an overall trend. Bar charts give detail; line graphs let you see the bigger picture. Both have their uses, but many inexperienced traders often forget to step back once in a while. The broader perspective is extremely useful for identifying long-term trends.
An upward trend is defined by higher prices, and even the lows are higher because falling stocks, commodities or currencies are bought up sooner. Similarly, a downward trend sees lower lows and also lower highs. This might seem obvious, but keeping this in mind can help you to spot trends when they might not otherwise be apparent.
When the trend ends
No trend lasts forever, and perhaps the most important indicators are those that show you when a reversal is on its way. Look out for the “Head and shoulders” pattern. This consists of three peaks with the biggest in the middle: a “head” flanked by two “shoulders”. After the second shoulder the price may drop away dramatically, ending the trend.
An upside-down head and shoulders is known as a breakout pattern, ending with the price steadily rising. “Double Tops” are another pattern showing two peaks preceding a consistent and dramatic drop in prices. “Double Bottoms” show the reverse: two extreme but more-or-less equal dips followed by steadily rising prices.
Triple tops and bottoms are also possible. The peaks and troughs should hit a consistent resistance line without breaking through. When they do, it’s the end of the pattern and the beginning of a new trend.
Go with the flow
Following a trend, or going with the flow, is almost always the best option. The temptation to go against the trend and, you imagine, make a killing when it goes into reverse is a classic novice mistake. This is the kind of risky move that should only be attempted by seasoned professionals, but it’s always the over-ambitious amateurs that attempt it. Why? Because they over-estimate their insight, while the experienced professionals know that “the trend is your friend” and that going along with it is the best way to make real gains. Instead of trying to buck the system, they put their efforts into predicting where it’s going next. The secret is to be ahead of the game rather than to go against it.