I am always talking about the market's trend, but what is a trend? In layman's terms, a trend can be defined as the market's overall direction, which means it can take three possible paths: Up, Down and Sideways. An uptrend is defined as a series of higher highs and higher lows. A downtrend is identified by lower highs and lower lows. A sideways trend is identified by a lack of market direction (and traders pulling large clumps of hair out of their heads).

Timeframe
That's not so hard, right? So, let's take a look at a chart. Tell me, what is the trend in the iShares Nasdaq Biotech Index (IBB -- see below)?

The correct answer is: up and sideways.

Although that might seem like an unusual answer, it is actually the correct one. The gap higher that started last week allowed prices to rise above the big red candlestick from late June. That gave IBB a new high with an interim low above the prior low. So, the short-term trend is a positive one.

However, IBB has yet to exceed its early-June high, so this fund's medium-term trend is actually sideways. If prices break out above the early-June peak, then we will be able to say that the medium-term trend is also up. However, if prices first drop below IBB's low from the latter part of June, then we'd say the medium-term trend is down.

I have not shown a longer-term chart here. As an exercise, I generally look at a monthly chart to determine that trend.

Of course, this analysis is all too simple, and I have not yet burned enough trees with this week's report, so I will now complicate things a bit more for you.

Moving Averages
There is more than one way to identify a trend. Another method uses moving averages. If prices remain above a moving average, then the trend is up. If a stock or fund falls below its moving average, then the trend is down. But which moving averages should we examine when analyzing a chart? Usually, short-term trends are identified by moving averages in the 5-day to 20-day range. A medium-term trend would be identified by a 50-day moving average. And finally, the classic long-term trend is identified via a 200-day moving average.

Many trading systems are built off moving averages. A simple one is to buy when price crosses above the 20-day moving average and sell when it falls below the 20-day moving average. This works well when the market is trending nicely in one direction, but if the market is trending sideways, then look out! In this particular case, you could lose giant sums of money as a stock's price crosses back and forth over its moving average, earning your broker a nice living while lowering your net worth at the same time.

Look at the sample chart above. Assuming you sold the morning after IBB closed below its 20-day moving average in June, you would have been stopped for a pretty good-sized loss. Late February into early March, and part of April also, would have resulted in losses. However, the huge gain from mid-April into June would have more than made up for those losses.

To help out with trendless markets, you can filter your moving average system with an indicator that helps identify whether the market is trending strongly or not (such as the Average Directional Index, or ADX, which I wrote about in our June 16th ETF Authority issue).

Trendlines and Channels
Technical analysts have a number of other tools at their disposal that they can use to identify trends, including momentum and volatility breakouts, as well as trendlines and channels. We'll discuss these and other topics in the coming weeks, so please stay tuned!

Summary
I hope this brief primer helped you to better understand what I mean by "trend". I use all of the tools noted above in helping me to determine what direction the overall market (or a particular stock) is trending. I also use the Elliott Wave Theory very heavily (for those of you familiar with Elliott Wave, remember that the trend is the direction of the impulse moves). That is beyond the scope of this lesson, although I do give a brief overview of Elliott Wave Theory in my free five-part trading course -- The ETF Money Machine -- which you received when you subscribed (click here to view this course on our web site). I have also written a book on the subject, Applying Elliott Wave Theory Profitably, which is set for publication by John Wiley and Sons later this summer. For a limited time, you can save 30% when you preorder this book today. VISIT THIS LINK TO LEARN MORE.

Steven Poser
Editor
The ETF Authority
New York, NY