Among all the basic concepts of technical trading, the “trend” is the most important. Many traders have said: “The trend is your best friend,” and they are correct. Here is an example of a downtrend in today’s Russell 2000 Futures market.
Experience proves that one of the common practices of traders who are profitable in the markets is that they follow the market trend rather than trade against it. To trade successfully traders must have a way of clearly defining and recognizing trends especially when and where a trend begins and ends.
Practitioners of technical analysis assume that prices move in trends and once begun, a trend will continue for some period of time. They are concerned with identifying a price reversal at an early stage and riding it until the evidence proves that the trend has once again turned. For them identifying the direction of the trend is the prime directive of trading; and identifying trends at their early stages, is seen as the foundation of success.
Let us begin our analysis of trends by first defining what a trend is. “Trend” refers to the general direction in which market prices are moving. It refers to something that is repeated – a continuation of events. If we know the general direction in which prices are heading, we can achieve a profit by simply “riding” the natural course of the market.
In trading an uptrend is defined by a succession of prices that exhibit higher highs and higher lows. A downtrend is defined by a succession of prices that exhibit lower highs and lower lows.
Using these definitions, we can identify a trend on any chart. In a very good trend the majority of price bars adhere to the definition of the prevailing trend.
Now this definition of a trend may seem very straightforward however there is more to it than is evident at first. Theoretical mathematicians may not be satisfied with these empirical definitions. They want to know the underlying “why.” They ask, “Why is it that higher highs and higher lows define an uptrend?” And why do lower lows and lower highs define a downtrend? Why do these definitions of a trend work? We’ll discuss about these “WHYs” in the upcoming blog.