What Are Trends and Why Do They Occur?
This article is about trends, and why they occur. Learn why trends are important in trading.
Firstly, what are trends? A trend is a price movement that tends either upwards or downwards. Trends are found in nature. For example, when winter becomes spring, temperatures do not immediately increase, and there are still cold and rainy days, but over time, the increase in temperature becomes evident. Similarly, market trends will exhibit ups and downs, but the overall price movement is in one direction.
A uptrend exists when prices form higher highs and higher lows, conversely a downtrend forms lower lows, and lower highs. In essence, prices tend to move in a similar direction over time.
Statistically, this does not appear to be random. Experiments with random numbers don’t result in trends that exist as long as those found in the markets. Currency markets are noted for particularly long trends.
Why does this occur? There are several explanations.
Firstly, information is progressively assimilated by the market. This results in prices steadily moving in one direction towards a target price as market participants progressively reduce the risk of that information being incorrect.
Secondly, a trend may be self reinforcing. The fact that prices have moved in a particular direction tends to create buying and selling pressure in that direction, thereby reinforcing the trend.
The main issue with trends is actually identifying the turning point of the trend despite noisy price action. This is discussed further in another article.
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