Investors and traders of equity don’t have a lot in common. They choose their stocks differently, have different investing goals, and take different amounts of risk. However, market trends are very important to both of them. In fact, a fair understanding of market trends is sometimes enough to make or break an investor in the long term.
In this article, we’re going to explore what market trends are, how to identify them, and how to use them to your advantage.
What are market trends?
Market trends allow you to figure out if stocks are, in general, moving up, down, are relatively stable, volatile, or just moving sideways. Trends can also sometimes help you to understand why the market is behaving the way it is and how you can profit from those movements (or lack thereof).
For instance, historicals will usually tell you a lot about the market. Every time there’s a crash due to a recession or other economic factors, most major indexes like the NIFTY 50 or the S&P 500 will eventually revert back to normal within a year or two. What might seem like a rash decision to buy really low usually turns out very well for retail investors every single time there’s a crash.
How would you define a trend?
While different people think of trends differently, the simplest way to explain the concept is to think about it in terms of general direction. If the market is bullish, you know that even though there might be some red candles here and there, the general direction of the stock is upwards. The same goes for bearish trends.
Generally, the longer a trend stays its course, the stronger it becomes. Going long on a stock that shows a bullish trend is a good thing, for instance.
Although everyone from long-term investors to scalpers follow trends, there are different kinds of patterns these people are typically looking for:
- Long-term – Spanning months or years, these trends reflect major economic cycles and industry shifts. Making money off these trends requires patience.
- Medium-term (swing) – These last a few weeks or months and offer opportunities for tactical trading based on economic changes, policy developments, etc.
- Short-term – These trends last only a few hours during the day and are ideal for active traders that use a lot of leverage to profit off of small increments or dips.
How to identify trends in the stock market
There are two ways to identify trends in the stock market – technical analysis and fundamental analysis.
Technical analysis relies on historical price and volume data to identify trends and predict future movements. Tools like charts, trendlines, and technical indicators (e.g., moving averages, RSI) help visualise and analyse trends. Technicals are often hard to learn and are slightly unreliable, depending on who you ask. While they are always a necessary addition to any research, technicals shouldn’t be the only thing you’re buying or investing on.
Fundamental analysis, on the other hand, focuses on a company’s financial health, industry outlook, and competitive landscape to assess its long-term potential. While not directly predicting trends, it helps validate their sustainability and is usually a more reliable way of judging an investment for the medium or long-term.
Trading the trends
Trading a bullish trend
If you notice that the market’s going up consistently, there are a few ways you can make money.
- You could just buy the stock and wait for the price to go up if you don’t want to take a lot of risk and invest for the long term.
- You could buy call options or long futures for the stock if you’re looking to take more risk for more potential upside in the short-term.
To get out of the position, look for potential resistance in the stock price near your price target to book profits. Make sure you’re placing stop-losses diligently.
Remember to combine technical and fundamental factors to be as accurate in your trading as possible.
Much like trading bullish trends, you do everything the same way but opposite. For instance, instead of buying the stock, short it. Instead of buying call options, buy put options (or sell call options, depending on your strategy).
This is one of the trickiest situations you could find yourself in. If you know the market is moving sideways, you could scalp small movements with a lot of leverage. This is, however, a very risky approach and if you’re new to trading, we encourage you not to use margin. That is a surefire way of either making a lot of money or losing all of it.
Also Read: Risk management in stock market
Things to keep in mind
- Trends are not guarantees – The past doesn’t always predict the future. Unexpected events, news, and market sentiment can disrupt even the strongest trends. Stay diversified and always use stop losses.
- Overconfidence is a recipe for disaster – Never assume a trend will continue indefinitely. Always have a risk management plan and be prepared to adapt. It helps to set target returns and stick to them.
- Technical analysis is a tool, not a crystal ball – Don’t rely solely on technical indicators; combine them with fundamental analysis and a healthy dose of scepticism.
- Emotions are the enemy – Fear and greed can cloud your judgement. Stick to your trading plan as far as possible and don’t make impulsive decisions.