The basis of technical analysis is to identify a trend and then trade in that direction. There are a number of different ways to identify a trend and today we will take a look at some of the tools in the D2MX Chart system that can assist you with this process. D2MX Charts are part of the D2MX Trade Tools plugin available in the d2mxIRESS, Bourse and Market Analyser platforms.
The simplest way to identify a trend is to take a look at the bars or candlesticks on a D2MX chart. A series of green candles or bars show a rising trend while a series of red candles or bars show a falling trend. Using this simple analysis allows you to quickly identify a trend. It works particularly well in longer timeframes, like weekly or monthly as some of the “noise” is filtered out.
Taking trend analysis one step further we can take a look at the definition of a trend which was created by Charles Dow, who also created the Dow Jones Index. This is known as Dow Theory and states an uptrend is defined as a series of higher lows and higher highs. A downtrend is defined as a series of lower highs and lower lows. At a transition between trends the share fails to make a higher high and forms a lower high. This is not yet a downtrend, until it breaks below the previous low (blue line) to form a lower low. From this point on there is now a downtrend in place.
You can also use trend lines to define the direction of a trend. A downtrend line is drawn above the share price joining up as many of the highs as possible. This line is then monitored for a break to the upside signalling a change in trend. An uptrend line can be drawn underneath the share price joining as many lows as possible. A break in this line signals a change in trend. A word of caution however – a break in a steep downtrend line may just mean the share is no longer going down as fast as it was.
Take a look at the chart below for an example of a break in the downtrend in GRY. The initial breakouts did not signal the start of a new uptrend, instead the share is no longer falling as fast. A break of a flat trend line, close to horizontal, is better as the share price has no choice but now to move higher.
Other than just looking at the chart and the candles you can use indicators to identify trends as well. The most common of these is the moving average. If the share price is above average it is rising and if it is below average it is falling. While this simple definition can work, it is more common for two moving averages to be combined to identify a trend. When the faster moving average (red line) is above the slower moving average (blue line) then the share is in an uptrend and when the moving averages turn down and the faster crosses below the slower average the share is now in a down trend.
One more indicator that is widely used to define a trend is the MACD. Before a moving average crosses over the two averages must come closer together. The MACD is an indicator based on the distance between two moving averages. The MACD was originally calculated as the difference between a 26 period and a 12 period moving average (red line). A signal line of 9 periods (blue line) is then used to provide a crossover signal similar to that which occurs in a moving average. The indicator is also displayed in the chart below as a histogram, with bars above and below the zero line.
We have looked at a number of different ways here to define a trend. It is obviously not possible and certainly not recommended, to use all of these approaches. Choose one that you are comfortable with and then stick with it.