In this third installment on how to chart stocks, we’ll discuss how to spot trends and what they mean. Common Wall Street phrases are “Trade with the trend,” and “The trend is your friend.” To see the start of the series on charting, go here.
To understand trend analysis, the first thing to understand is that there are trends corresponding to all of the different time frames and these trends may or may not be moving in sync. Short term trends are price movements that last a few days to a week or two. Medium term trends last weeks to months. A long-term trend lasts for years. Really long-term trends may last for decades. The trend you are looking at depends on the time increment of your chart. A weekly chart is good for spotting short-term trends. A yearly chart is good for looking at medium term trends. A 5-year chart is good for long-term trends.
The trends that will be of most use to this audience are the short and medium-term trends. The long-term trends for any stock you are considering should be upward since you should only be looking at stocks that are growing and have regularly increasing earnings. The short and medium trends are most useful for spotting opportunities to buy into a stock (or sell) and set a limit price.
To find a trend, first start with a chart of the appropriate time increment. For example, let’s look at the Aflac 1 year bar chart:
A trend is created by drawing a straight line from either troughs to troughs (in the case of an uptrend), or peaks to peaks (in the case of a down trend). Aflac was in a downtrend from March through September. This downtrend steepened in slope during the May period. The trend lines would look as follows:
Notice that the price of the stock broke through the trendline in early November. This is the first sign that the medium-term trend was changing. The other two things that would need to happen are 1) The stock must set a new high above the previous high set in August and 2) the next low in the stock (before it goes up again) must be above the October low. It is questionable whether the stock will do this given that it seems to be meeting some resistance at the ceiling set at about $45 per share.
Let’s look at the short-term trends on the same stock. these are seen here:
Notice that the short-term trend changes much more often than the medium-term trend. Notice also that there are periods like the late June period and the November period where the stock is not really going anywhere. This is called “drawing lines.” If a stock draws lines for a long period of time, it becomes a floor if the stock moves up out of the range. or a ceiling if the stock moved down below the range. Floors and ceilings were discussed in the last post.
In the next post in the series, I’ll discuss using trends and floors and ceilings to determine limit prices.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.
Clipart from clker.com