Terms

Trending Market What it Means How it Works

Trending Market What it Means How it Works

Trending Market: What it Means, How it Works

What Is a Trending Market?

A price series that continually closes higher or lower is said to be trending. An upward trending market fluctuates but tends to close higher on average. A downward trending market ends lower regardless of interim moves. Securities in any asset class tend to show trending behavior.

Key Takeaways

  • Trending markets drift higher or lower.
  • All trending asset prices represent trading and investing opportunities.
  • Technical analysts study trends to identify when a trend may end or change.

Understanding Trending Markets

The Efficient Market Hypothesis (EMH) posits that markets are not predictable through prior information. Prices should exhibit a random walk over time. However, trends are not anomalies. Trends are commonplace in any asset class.

A trending market provides trading opportunities for investors, traders, and technical analysts. Technical analysts chart the price pattern of a security or market index to identify trending directions for investment trades. Investors may follow the trending direction of an index that serves as a benchmark for a specific security. These trending market lines can serve as an overlay to a security price chart, forming an additional indicator for market trends.

Trending markets are of primary interest in technical analysis. Technical analysts believe that trending markets occur regularly and predictably. The ability to discern these trends correctly can impact investment returns.

Identifying a Trending Market

Traders use patterns and trend lines to identify trending market directions and trading signals for a single security. A trending market can be classified as short-, mid-, or long-term. Trading channels can be drawn to follow a security trend. Common trading channels include:

  • Ascending: In an ascending channel, a security shows a bullish trend represented by positive sloping trend lines.
  • Descending: In a descending channel, a security shows a bearish trend represented by negative sloping lines.
  • Sideways: A security or market index can show a sideways channel, represented by zero-sloping trend lines.
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To indicate buy and sell signals, traders can use resistance and support lines assuming the price remains within its trended pattern. When a price reaches a resistance line, sell orders can be initiated to benefit from a potential reversal to a bearish trend. Conversely, when a price reaches support lines, buy orders can be initiated to profit from a potential reversal to a bullish trend.

Standard trading channels do not fully encompass price movement through reversals and changing trends. This can lead to the use of wedge price patterns, which are ascending or descending channels with non-parallel trend lines pointing to a potential trend reversal.

Envelope channels can also be used to broaden the range of price levels and provide a single channel used over a long period of time. Envelope channels use non-linear trend lines drawn at resistance and support levels to create a moving channel that can encompass both bullish and bearish trends.

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