You might have seen technical analysts analyzing charts on various business news channels and telling that a particular stock is in uptrend/downtrend. When we say a stock is in uptrend it means that we expect stock price to move upwards in near future. Similarly, when we say a stock is in downtrend it means we expect stock price to move downwards in near future. You would have noticed that prices rarely move in a straight line. Even if the stock price has moved up, over the last year, there will be days or months when it would have moved down, compared to the previous close. So how do we define a trend? Technical Analysis says that if the stock price is moving up and making higher highs and higher lows, it is in uptrend. Let’s understand this through an example.
Suppose you decide to analyze traffic situation at a nearby signal. You know that signal becomes green in every 5 mins and remains open for the next 5 mins. At 6pm you observe that there are 100 cars waiting at the signal which just turned red. The signal will become green at 6:05 pm and will again become red at 6:10 pm. You observe that in every 5 mins 30 cars arrive at the signal and add up to the queue. In the 5 mins, when signal is open, 50 cars pass by. Let’s note down your observations at various points of time
|At 6:00 PM
|Signal just turned red and there are 100 cars waiting
|At 6:05 PM
|In last 5 mins, 30 cars were added to the queue and now the number of cars waiting at signal is 130. Signal turns green.
|At 6:10 PM
|50 cars pass by when the signal was open, but 30 were again added in the last 5 mins. So total cars at the signal are 130+30-50 = 110.
|At 6:15 PM
|Again 30 cars were added to the queue. Number of cars become 110+30 = 140. Signal becomes green.
|At 6:20 PM
|50 cars pass by in last 5 mins when the signal was green, but 30 were again added. Now the number becomes 140+30-50 = 120
As we can see, no of cars at the signal makes a higher high in every 10 mins starting 6:05 PM. At 6:05 PM it was 130 which became 140 at 6:15 PM. This will become 150 at 6:25 pm, if you keep calculating. This is an example of uptrend. You can see this trend in the first half of the chart below.
At 6:25 pm, we can say that no of cars at the signal are in uptrend and we expect them to increase in near future.
Let’s say you observe that around 7 pm, it starts getting less congested and only 25 cars are added to the queue in every 5 mins, instead of 30 cars. Previously 60 cars were getting added to the queue in every 10 mins and only 50 were moving out, as the signal only opens for 5 mins in a 10 min window. After 7 pm the situation has changed. Now, only 50 cars are getting added in every 10 mins and we know that same number of cars will move out, in 5 mins when the signal is open. So now the traffic has become stagnate. It’s neither increasing nor decreasing, as 25 cars are added in every 5 mins but in next 5 mins, 50 move out. This situation is depicted by the middle part of the chart below.
After 7:30 pm, you observe that only 20 cars are getting added to the queue. Now the pattern will make lower highs and lower lows. We recommend trying this scenario yourself. Traffic situation will improve because we know that only 40 cars are added to the queue in every 10 mins and 50 cars are moving out. We can clearly say that no of cars at the signal are in downtrend and now we expect them to decrease with time.
If we join all the highs, it’s called resistance. If we join all the lows, it’s called support. Keep reading, as we go in details of trend, support and resistance in our next post.