Trend & Market Cycles

Table of Content

What Is a Trend?

A trend is the overall direction of a market or an asset’s price. In technical analysis, trends are identified by trendlines or price action that highlight when the price is making higher swing highs and higher swing lows for an uptrend, or lower swing lows and lower swing highs for a downtrend.

Illustration Of Trend Types:
Trend Types

Many traders opt to trade in the same direction as a trend, while contrarians seek to identify reversals or trade against the trend. Uptrends and downtrends occur in all markets, such as stocks, commodities, cryptocurrencies, bonds, and futures. Trends also occur in data, such as when monthly economic data rises or falls from month to month.

Important Points To Remember:

  • A trend is the general direction of the price of a market, asset, or metric.
  • Uptrends are marked by rising data points, such as higher swing highs and higher swing lows.
  • Downtrends are marked by falling data points, such as lower swing lows and lower swing highs.
  • Many traders opt to trade in the same direction as the trend, attempting to profit from a continuation of that trend.
  • Price action, trendlines, and technical indicators are all tools that can help identify the trend and warn when it is reversing.

How Trends Work

Traders can identify a trend using various forms of technical analysis, including trendlines, price action, and technical indicators.

An uptrend is marked by an overall increase in price. Nothing moves straight up for long, so there will always be oscillations, but the overall direction needs to be higher in order for it to be considered an uptrend. Recent swing lows should be above prior swing lows, and the same goes for swing highs. Once this structure starts to break down, the uptrend could be losing steam or reversing into a downtrend. Downtrends are composed of lower swing lows and lower swing highs.

While the trend is up, traders may assume it will continue until there is evidence that points to the contrary. Such evidence could include lower swing lows or highs, the price breaking below a trendline, or technical indicators turning bearish. While the trend is up, traders focus on buying, attempting to profit from a continued price rise.

When the trend turns down, traders focus more on selling or shorting, attempting to minimize losses or profit from the price decline. Most (not all) downtrends do reverse at some point, so as the price continues to decline, more traders begin to see the price as a bargain and step in to buy. This could lead to the emergence of an uptrend again.

Trends may also be used by investors focused on fundamental analysis. This form of analysis looks at changes in revenue, earnings, or other business or economic metrics. For example, fundamental analysts may look for trends in earnings per share and revenue growth. If earnings have grown for the past four quarters, this represents a positive trend. However, if earnings have declined for the past four quarters, it represents a negative trend.

The lack of a trend—that is, a period of time where there is little overall upward or downward progress—is called a range or trendless period.

Using Trendlines

A common way to identify trends is using trendlines, which connect a series of highs (downtrend) or lows (uptrend). Uptrends connect a series of higher lows, creating a support level for future price movements. Downtrends connect a series of lower highs, creating a resistance level for future price movements. In addition to support and resistance, these trendlines show the overall direction of the trend.

While trendlines do a good job of showing overall direction, they will often need to be redrawn. For example, during an uptrend, the price may fall below the trendline, yet this doesn’t necessarily mean the trend is over. The price may move below the trendline and then continue rising. In such an event, the trendline may need to be redrawn to reflect the new price action.

Keep In Mind: Trendlines should not be relied on exclusively to determine the trend. Most professionals also tend to look at price action and other technical indicators to help determine if a trend is ending or not.

Illustration Of Trendlines:
Illustration Of Trendlines

What Are Market Cycles?

Market cycles, also known as stock market cycles, is a wide term referring to trends or patterns that emerge during different markets or business environments. During a cycle, some securities or asset classes outperform others because their business models aligned with conditions for growth. Market cycles are the period between the two latest highs or lows of a common benchmark highlighting a fund’s performance through both an up and a down market.

Important Points To Remember:

  • A cycle refers to trends or patterns that emerge during different business environments.
  • A cycle time frame often differs for each individual person depending on what trends they are looking for.
  • A market cycle often has four distinct phases: (Accumulation, Uptrend, Distribution, Downtrend).
  • It can be almost impossible to identify what phase of the cycle we are currently in.
  • At different stages of a full market cycle, different securities will respond to market forces differently.

Illustration Of Market Cycles:
Illustration Of Market Cycles

How Market Cycles Work

Newmarket cycles form when trends within a particular sector or industry develop in response to meaningful innovation, new products or regulatory environment. These cycles or trends are often called secular. During these periods, revenue and net profits may exhibit similar growth patterns among many companies within a given industry, which is cyclical in nature.

Market cycles are often hard to pinpoint until after the fact and rarely have a specific, clearly identifiable beginning or ending point which often leads to confusion or controversy surrounding assessment of policies and strategies. However, most market veterans believe they exist, and many investors pursue investment strategies that aim to profit from them by trading securities ahead of directional shifts of the cycle.

Special Considerations:

A market cycle can range anywhere from a few minutes to many years, depending on the market in question, as there are many markets to look at, and the time horizon which is being analyzed. Different careers will look at different aspects of the range. A day trader may look at five-minute bars whereas a real estate investor will look at a cycle ranging up to 20 years.

Types of Market Cycles

Market cycles are generally considered to exhibit four distinctive phases. At different stages of a full market cycle, different securities will respond to market forces differently.

The four stages of a market cycle include the accumulation, uptrend or markup, distribution, and downtrend or markdown phases.

  • Accumulation Phase: Accumulation occurs after the market has bottomed and the innovators and early adopters begin to buy, figuring the worst is over.
  • Markup Phase: This occurs when the market has been stable for a while and moves higher in price.
  • Distribution Phase: Sellers begin to dominate as the stock reaches its peak.
  • Downtrend Phase: Downtrend occurs when the stock price is tumbling down.

Keep In Mind: Market cycles take both fundamental and technical indicators (charting) into account, using securities prices and other metrics as a gauge of cyclical behavior.