Why Trend Analysis is a Helpful Tool in Identifying Trends and Making Money
- Vivek Kumar, CMT, CFTe
- Jan 3
- 7 min read
In the curriculum of the Chartered Market Technician® (CMT - The gold standard designation and program in Technical Analysis) course, we are taught that "price has memory and Price discounts everything including News / Corporate Results / favourable or unfavourable change in Management etc." and "markets move in trends due to their fractal nature." However, the retail trader often gets lost in a "sea of indicators," missing the primary direction of the market. Using a disciplined, rule-based approach is a helpful tool in identifying trends and making money because it removes the cognitive biases that lead to "catching falling knives and eroding your hard earned bank balance."
Table of Contents
1. The CMT Philosophy: Price is Primary
A CMT or a professional seasoned trader who uses Technical Analysis primarily doesn't look at 'why' a stock is moving; he/they look at "where" it is moving as once you have observed what trend it is, (i.e. uptrend / downtred) there is no meaning in searching for the "why", better plan your trade and punch that into your broker's terminal. Many traders fail because they attempt to outsmart the market by calling tops and bottoms due to this bias. Instead, accepting that the current price action is a helpful tool in identifying trends and making money allows you to join the dominant flow and become a successful trader in real life.
2. Dow Theory: The Structural Helpful Tool in Identifying Trends
Charles Dow’s principles remain the bedrock of technical analysis especially when it comes to identifying the trend. To a trader, a trend is not a "vibe"; it is a mathematical sequence of price points as per Charles Dow. He clearly structured the definition of trend as:
Uptrends: Defined by Higher Highs (HH) and Higher Lows (HL). As long as the previous Higher Low is not breached, the trend is technically intact.
(Note - Many professional traders including myself use the definition of 'breaching' using Closing price as this is the price point created by professionals, unlike the opening price, which is often influenced by amateurs which means if the previous Swing Low which was the 'Higher Low' in this case has been breached on Closing basis then the Uptrend now ceases to exist and I will no longer prefer any Long trades.)
Downtrends: Defined by Lower Highs (LH) and Lower Lows (LL).
(Note - Likewise, Suppose I am trading Silver ETF on 15 Minutes timeframe and at any moment the recent Swing High which is Lower High in this case has been breached and price has closed above that then I shall assume that the Downtrend cease to exist now and I shall refrain from initiating any Short trades.)
Recognizing these structures is the most basic yet effective helpful tool in identifying trends and making money in the long run. When the sequence breaks (e.g., a "Failure Swing"), it serves as your first warning to exit.
3. Moving Averages: The 200 SMA and Institutional Flow
While short-term traders focus on 9 or 20-day averages, the 200-period Simple Moving Average (200 SMA) is the "institutional line" for most of the professional traders.
The Slope Rule: If the Stock price is above 200SMA and the 200 SMA is pointing up, the long-term trend is bullish and is favourable for initiating any long trades.
The Mean Reversion: Prices often return to the 200 SMA during "secondary corrections" and revert back which may be a good buy point for a mean reverting trader or one who likes taking trades using Stochastic Indicator or MACD etc.
Using the 200 SMA as a filter is a helpful tool in identifying trends and making money on a consistent basis because it keeps you from buying stocks that are in a long-term structural decline. Additionally, there is another famous strategy used by many seasoned traders to use the 50 SMA in conjunction with 200 SMA to define trends.
4. Trendline Precision: Drawing with Technical Accuracy
A trendline is only as good as its construction and I have seen many people drawing trendlines the wrong way most of the times. In CMT circles, we emphasize three specific and permissible methods for drawing trendlines:
Connecting Lows: In an uptrend, a trendline must be drawn using only the 'low' prices, which act as swing lows.
Connecting Highs: In a downtrend, a trendline must be drawn using the 'High' prices only which will act as Swing Highs in this scenario
Connecting Close: Either in Uptrend or Downtrend, a trendline must be drawn using the 'Closing' prices only.
(Note- I have myself found this to be the most effective way of drawing trendlines and catching the early Breakouts in my entire trading career.)
The "Three-Touch" Rule: A line is just a "tentative" trendline with two touches; it becomes a "valid" and "immensly powerful" tool in identifying trends and making money effectively only after the third successful touch.
5. The Psychology of Trend Following: The Hardest Part
Identifying the trend is a science; staying with it is an art. The psychology of trend following is often the most overlooked helpful tool in identifying trends and making money or say trading trends for a living.
The Urgency to Profit: Most traders cut their winners too early because they fear the profit will disappear. A professional trader understands that the trend is likely to continue rather than reverse if he has clearly defined his uptrend / downtrend criteria. In my case, I use 200 SMA to define long term trends and there has not been a single day when I have bought any stock which is below its 200 SMA since the Year 2014 till now.
The Fear of Being Wrong: Traders often hold onto losers in a downtrend, hoping for a bounce. Using a trend-based stop-loss is not only a helpful tool in identifying trends and making money but also a necessity in these volatile markets these days because it preserves your capital for the next big move. For this purpose, you may use 10 SMA or 20 SMA in your ongoing trades as remember "No one has ever gone broke booking profits."
Patience: Trends take time to develop. The "boredom" of a long-term trend is often where the most money is made.
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People frequently asked below mentioned questions from Vivek on this topic - "Why Trend Analysis is a Helpful Tool in Identifying Trends and Making Money"
Why is price action considered a helpful tool in identifying trends and making money?
Because price is the only "coincident" indicator. Everything else (RSI, MACD) is a derivative of price.
Can a beginner use Dow Theory as a helpful tool in identifying trends?
Yes. Simply identifying if the latest "dip" stayed above the previous "dip" is a powerful helpful tool in identifying trends and making money.
How does the 200 SMA act as a helpful tool in identifying trends?
It acts as a filter. If the price is below the 200 SMA, you should generally avoid long positions, making it a critical helpful tool in identifying trends and making money.
What is the best timeframe for a helpful tool in identifying trends?
For swing trading, the Daily (D1) and Weekly (W1) charts are the most reliable and it helps avoid false breakouts most of the time.
Is a trendline break a signal to sell immediately?
Tehnically, YES. It is a signal that the "momentum" has changed. It often precedes a transition from a trend to a sideways range however I strongly recommend that the exit from your trade must be based on your exit criteria stated even before entering the trade.
What is "Relative Strength" and is it a helpful tool in identifying trends?
Relative strength compares a stock (like Reliance) to an index (Nifty 50). It is a top-tier helpful tool in identifying trends and making money by picking leaders. But it do not hel you identify trends, it will only show you the strength of the stock. Even falling stocks may have upward trending Relative Strength charts.
How do I avoid "false breakouts"?
Wait for a candle to close above the resistance or use volume as a confirmation helpful tool in identifying trends. I have personally found 'Volume' to be the most reliable source of information in identifying false breakouts.
Should I use SMA or EMA for identifying trends?
Professional traders use both or you may say it is something like 50-50 when it comes to the choise of EMA or the SMA. 50% of the traders prefer SMA while the rest of them prefer EMA.
The EMA is faster (better for entries), while the SMA is smoother (better for identifying the primary trend).
Can I use this helpful tool in identifying trends in the Forex market?
Absolutely. Market structure (HH/HL) is universal across all liquid asset classes.
What is the "Golden Cross" in trend analysis?
It’s when the 50-day SMA crosses above the 200-day SMA, a world-renowned helpful tool in identifying trends and making money while the opposite scenario is called the Death Cross.
The Historical Genesis: From Charles Dow to Modern Technicals
The journey of technical analysis as a helpful tool in identifying trends and making money began in the late 19th century with Charles H. Dow, co-founder of Dow Jones & Company. Dow’s editorials in The Wall Street Journal laid the cornerstone for Dow Theory, introducing the revolutionary concept that market averages discount all news and move in identifiable trends. Following Dow's death in 1902, pioneers like William Hamilton and Robert Rhea codified these observations into a systematic approach, establishing the "Three Movements" of the market: Primary, Secondary, and Minor. By 1948, Edwards and Magee published Technical Analysis of Stock Trends, often called the "Bible" of the field, which further refined chart patterns as a helpful tool in identifying trends and making money. The Critical Importance: Why the Trend is Your Only Friend In a modern era dominated by High-Frequency Trading (HFT) and noise, the ability to objectively define a trend is the technician's greatest edge. For practitioners like Vivek Kumar, CMT, CFTe, trend identification serves as a vital risk management filter.
Removing Cognitive Bias: A systematic approach acts as a helpful tool in identifying trends and making moneyby overriding human emotions like greed and fear.
Positive Expectancy: Trend following doesn't aim to predict tops or bottoms; it aims to capture the "meat" of a move. By ensuring you trade in the direction of institutional flow, these methods provide a sustainable path to long-term profitability.
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