"Trending markets are one of the most cited market phases among trader. Regardless of which markets you look at, trending markets are most often talked about. A trending market occurs when the market positioning leads to either a demand in the prices, thus leading to higher prices or there is very less in the markets leading to a supply in the prices which leads to prices falling over a prolonged period of time. Trends are most commonly occurring in commodity markets, but you can also find trends in the forex markets. The concepts of trending markets was first postulated by Charles Dow who observed some recurring patterns in the markets. In this article, we take a look at what are trending markets and what are the different types of trends that are formed. Because trend based trading is one of the most commonly used type of trading, it is important for the trader to understand how trending markets work."
Trending markets is a phrase given to a type of market behavior. As the name suggests, trends in the markets occurs when price has settled to move in one direction. This direction can be either to the upside or to the down.
Many traders prefer to trade during trending markets. The reasons are obvious of course. In a trending market, there is only a small chance to end up on the wrong side of the trend. A market trends because that is how a majority of the traders are positioned (in the direction of the trend), which leads to price continuing in its direction.
The fascination with trending markets if seen by the sheer number of trading systems and strategies that focus on trending markets. However, this is not always the case. Despite the popularity of trading with the trend, trends are only formed 20% of the time. For the rest of the time, price tends to move in a sideways market.
However, the main difference is that during a trending market, profits are realized rather quickly than compared to the sideways market. Trends are formed because of the general perception of the underlying asset.
There are two major trends; the uptrend and the downtrend.
An uptrend is where price tends to move higher, forming higher lows and higher highs. Meanwhile, a downtrend is where price tends to move lower, forming lower lows and lower highs.
Trends are set in place when there is a general perception that the asset in question will continue to appreciate or depreciate depending on the investor’s view.
The concept of trends
The concept of trends was first introduced by Charles Dow. Known as the Dow Theory, Charles Dow postulated that there are three types of trends in the markets. These were the major, primary and secondary.
The major trends were those that lasted over a couple of years, while the primary trends lasted from a few months to a few years. Finally, the secondary trend were those that lasted from a few weeks to a few months.
As you can see, the three major types of trends would at times move in opposite directions. These are nothing but corrections to the major trends.
Depending on how the trends fared, traders were able to trade either the correction itself or wait for the correction to be completed in order to trade in the direction of the major trend.
This same concept can apply to the short term markets as well. Depending on the time frame of your choice, you can find trends that occur on the Weekly, Daily and smaller time frames.
Traders often make use of multiple time frames to ascertain these trends in what is known as multi-time frame analysis.
How to identify trends?
There are a number of ways to identify a trending market. The concepts range from using just the price action or using a mix of technical indicators. Typically, a moving average is used as an indicator to gauge the direction of the trend.
Traders make use of two moving averages (a long term moving average and a short term moving average) to identify the bullish and bearish trends. When the short term moving average is above the long term moving average, it indicates a bullish trend in the markets.
Likewise, when the short term moving average is below the long term moving average, it indicates a bearish trend in the markets.
Besides the moving averages, other indicators that are used as a way to detect the trends include the average directional index (ADX) or the Ichimoku cloud indicator.
You can also ascertain trends by not just the technical indicators but also price action. The general rule of thumb is to use trend lines. Trend lines are an integral part of understanding trends.
Trend lines are plotted by either connecting consecutive higher lows or lower highs, on bullish and bearish trends respectively. When the trend lines are breached, you can expect to see either a retracement or a reversal of trend in itself.
For most traders, trend based trading is one of the most ideal ways to trade. This allows them a sense of safety as their position in the direction of the majority traders and investors. However, the timing of the trends plays an important role. Knowing when to buy or sell into a trend is important.
This is often the means of technical analysis. Traders make use of various concepts including wave counting in order to understand at what point the trend is in currently.