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Trends

tendencias

Market stages

In technical analysis, analysts base their opinions on market trends, or the stock behavior, which usually follow some flows (up or downwards). The market can follow three diffenrent trends: upwards, downwards and horizontal. Trends can also be separated in three stages: primary, secondary and tertiary.

The primary phase lasts about 1-2 years, indicating the main direction of the market. The secondary trend is a trend intermediate, which is within the primary correction trend and lasts from 3 weeks to a few months. The tertiary trend lasts less than three weeks, representing short-term fluctuations in the secondary trend.

Stages for a hiking market

The first phase in the high market, the primary phase, occurs immediately after the lower end of the market. That’s when smart investors begin to buy the shares at a very low price, generally investing in the long term, even when most of the market is pessimistic, the news is not encouraging, and everyone thinks that the downtrend is not over yet. Thus, the actions form an ultimate depth, and then immediately begin to rise.

A second stage, called secondary, is a bit longer, and happens when the market is already convinced the prices are not dropping anymore, and most people are optimistic. The majority of the investors come back to the market during this stage, supporting a huge increase on prices (hoard effect) and maximizing the profits for the upward trend.

A third stage comprises the euforia of the markets, in which delayed investors just start buying. In this stage, speculation is huge and prices become artificially inflated, and the markets excessively optimistic. You can enter and earn a little money, but it is also the time that large investors start to think to sell their shares.

Stages for a shrinking market

The primary phase in the bearish market is characterized by a decrease in volume traded stock, signaling that few people are negotiating the shares. Here, the news is still bullish, but the prices are pretty high, but investors (especially those who have not taken advantage of the high principal) continue to buy every new zigzag market, but without overcoming a major strength, beginning to form a pivot low.

The secondary stage comprises a huge drop on prices. Here, the major investors sell shares off, making their profits. Thereafter, many other investors follow their move, selling more shares. The hoard effect arrives in the market and everybody quits from these shares. The trend lasts some time, and pessimistic news flood the market, with large trading volume and a general downward move on prices.

The third stage is the desperation, where the markets keep dropping and investors who didn’t left their positions start selling shares with huge losses. News are pessimistic and the market keep falling down until getting a considerable levelling down. When this stage ends up, a new upward move tends to happen, starting a new cycle.

The explanation seems to be a bit obvious, but guessing when those stages will take place is quite difficult, even using graphs. We can never know whether a share is really overpriced, or underpriced, as it always can lose all of its value. The ideal is to track historical data, find some confirmation of peaks or troughs based on trading volumes and other indicators, like moving averages or the relative strength index, among some other indicators.

Trends emerge when prices move towards a specific direction, for a period of time and forming a graph with visible peaks and troughs. Then, three paths are possible: a hike, a drop or a steady trend.

Upward trend

An upward trend indicates a general price hike, in which buying may be indicated to increase gains. This trend is formed when you have a succession of ascending tops and bottom, where each new top is formed higher than the previous top, and each new fund formed is higher than the previous bottom. The logic for having such trend is that with prices hiking, people believe they will keep increasing, accelerating buying moves and making it real. The graph below shows an upward trend for FIBR3 shares:

Tendência de alta

Downward trend

The downward trend indicates shrinking prices, in which selling is the most indicate procedure to increase profits. This tendency is formed when there is a succession of top and bottom, where each new top is lower than the former top and each new bottom is lower than the previous bottom. In this trend, investors are willing to sell shares at lowering prices. No prices are so low that can’t drop even more, so investors have to be aware about the right timing to buy. The graph below shows a downward trend for CSN’s shares:

Tendências de baixa

Horizontal trend

The horizontal trend happens when peaks and bottom tend to become closer and closer to each other, which indicates a balance between selling and buying moves, or even uncertainties about the future trends. The graph below shows an horizontal trend for Bradesco’s shares:

Tendência Lateral

To find a trend line, one must link the maximum number of dots in a graph, joining peaks and bottom and tracing a straight line between them, not arrays like in the candle stick graphs. The closer the dots are from the line, the more consistent the trend shall be. A trending line which passes through three different dots is more reliable than another which passes through just two dots.

Support and resistance

Support level is the prices level reached by a share where the downward move stops, and the buying pressure once more exceeds the selling pressure. In other words, that’s the lowest level that can be reached by prices, where there is a psychological barrier that hinders the falling prices. Look the following graph:

Suporte e Resistência

Vale5’s prices keep changing up and down, as time goes by. However, as prices nears the R$ 31.50 level, shares move up again. This movement happens at least three times in the example. As prices come closer to R$ 31.50, the number of sellers drop and buying pressure increases with investors taking advantage of the relatively lower prices.

That happens because people can remember things, and the recollect all values paid or received from buying and selling shares, as well as the levels in which they earned or lost money. The memories provide a strong support for trends, and create psychological barriers at certain levels of prices. That doesn’t mean VALE5 shares will hike back any time they reach R$ 31.50, but still provides an indication of  likelihood.

Likewise, the resistance is formed from pricing memories and beliefs from investors. It appears when increasing prices suddenly stop hiking, and the selling pressure surpass the buying pressure. In the example, when VALE5 prices nears R$40-41.00, most people start selling shares for realizing profits.

The longer supports and resistance are and the more they are tested, the stronger will be the evidences. Remind that when a resistance is broken, or maximum pricing level is finally exceeded, it becomes a support. The same happens when a support is broken, or the minimum prices are reached. The process is called “reversal”.

Principle of reversion

The principle of reversal, as the name suggests, indicates a possible trend swap. Once prices change within an array, forming psychological barriers, we can determine both support and resistance levels. Every time that they are tested and confirmed, investors become convinced about the interval of prices to work with. Besides, when supports and resistances last longer, they become more factual, because it has already been tested many times, for long. Pricing levels are not everlasting though, and can break those barriers, moving to a new array of pricing. Look the graphs below:

Inversão

When a pricing array breaks a resistance, it becomes a new support for the array of changing. If investors bear a level in mind and it is broken on top, they automatically increase purchases, as the shares keep hiking with the psychological barrier exceeded. This factor causes the stock to rise effectively. Even those who sold shares when they reached the resistance will be looking for buying them back, taking advantage of the hiking wave and recovering their positions.

The opposite is also true. When prices break a support, it becomes a new resistance. When prices touch the support line, investors think prices will bounce back, and buy new shares. However, as their thoughts prove to be wrong, losses start to appear. So, once prices again reach the old support, they sell positions and increase the selling pressure on prices, making quotations to fall once more.

We can prove reversals in upward, downward and horizontal trends by using channels. Channels are nothing more than pricing moves between two parallel lines, one of them working as support and another as resistance.

Upward channel

The upward channel shows the Market trends until prices break the support level. Look at the graph below:

Cana de Alta

We can observe that prices touch the upper line and the bottom line 4 times each. Every time the bottom line is touched, prices begin to rise. When the top line is touched, prices start to fall. So, by using the technical analysis principles, the investor should buy every time prices touch the bottom line, selling as soon as they reach the upper line. However, one of the lines will be eventually broken. If that happens through the upper line, prices skyrocket, if it breaks in the bottom, that indicates aturnaround or a price correction at least.

Downward channel

This channel shows the downward trend for na asset, until prices break the resistance. Look the graph below:

Cana de Baixa

The graph considers CSNA3, and there is a clear downward trend. The support is touched 5 times and the resistance three times, until it is broken. When that happens, prices hike aggressively. So, by using the technical analysis principles, as soon as the resistance is broken, the investor should buy the asset, as a hiking trend is underway.

Horizontal channel

Horizontal or side channels expose a scenario of steadiness for prices, showing a balance between sellers and buyers. Look the graph below:

Cana de Lado

The graph considers USIM5, and prices keep changing within the range of R$ 22.00 e R$ 25.00, and that indicates nobody is quite sure about the trend for prices. However, by March they broke the resistance and gained momentum.

Volume

Analyzing trading volumes during a period or session is also crucial for technical analysis, and a key fator for testing trends or reversals. For instance, a move with a weak volume is not considered consistent, and should be reversed soon.

The volume is a key indicator. As prices hike, investors increase buying and the trading volume. When the Market drops, though, those who bought don’t want to sell at losses, holding positions. Thus, trading activity lowers and volumes drop. In a downtrend, the volume does not need to confirm the fall, because gravity alone helps to bring down prices. Equivalence between volumes and prices works as follows:

Price

Volume

Trend

If prices increase

And the volume is high

Trend is upward

If prices increase

And the volume is low

Trend is downward

If prices drop

And the volume is high

Trend is downward

If prices drop

And the volume is low

Trend is neutral

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