This applies to all financial assets, including bonds, stocks, and foreign exchange. In a normal market, the price can experience an uptrend or a downtrend.
The uptrend refers to a bull market, while the downtrend is a bear market. The investors determine the market’s direction.
Unfortunately, most investors prefer the uptrend and have made profits for decades. But have you ever thought of going short? Have you ever tried following a downtrending market?
What is a Downtrend?
Unlike an uptrend characterized by higher lows and higher highs, a downtrend features lower lows and lower highs. This type of trend describes the investors’ sentiments, with the sellers winning and forcing a downward trend.
The downtrending pattern on your price chart results from a sequence of successful lower bottoms and lower tops. Therefore, it is composed of lower-swing highs and lower-swing lows.
If the price continues making the lower swing highs and lower swing lows, the trend will be intact. The securities in a downtrending pattern can continue dropping until the market’s condition changes.
A downtrend represents a deteriorating market and rarely makes an instantaneous change. Instead, the signs of a strain in the price market after the first change can force the market downwards. Some signs of a downtrending pattern include:
Supply Exceeds Demand
The first sign of the downtrend formation is a unique point in the market where the supply exceeds demand. Or the sellers overpower the buyers. Generally, the quantity of security the sellers want to sell is more than the number of buyers.
Increased Number of Investors (Sellers)
The second sign of a change in trend is an increase in the number of investors convinced that they can now start selling.
This goes hand in hand with the reduction in the number of buyers. The increased number of sellers forces the trend to change downwards. This means the formation of more low-swing highs and lows.
Last but not least, new information or financial news can help confirm the suspicion of the buyers. The news can force buyers to close their positions. It can also help confirm that it’s not the right time to purchase a security.
And as more buyers close their positions, the sellers become eager to limit their potential losses while taking profits.
How to Trade Downtrend Patterns?
Most traders tend to avoid the downtrend and focus more on trading long and uptrends only. Fortunately, they can be found in different timeframes, which include minutes, weeks, and days. Therefore, traders do everything possible to detect a downtrend as soon as possible.
Some traders prefer trading short and long, so they examine a downtrend for new opportunities. Unfortunately, when they detect a downtrend, some traders proceed with caution, especially when looking for a long position. Their hesitance in going long helps intensify the downtrend by reducing the demand.
To make a profit, the short sellers can borrow and sell the shares at a price before buying them back. This is referred to as short selling. When the price continues downtrending, then your profit margin increases. Therefore, they make a profit from the following low swing while waiting for the downtrend to continue.
Downward sellers force the trend to continue by entering positions with sell orders. These traders use chart patterns and technical indicators to confirm a downtrend. The moving averages can help you identify the market’s overall trend.
Remember, the downtrend is still strong if the price is below the moving average. Technical indicators like the (ADX) Average Directional Index and the RSI (Relative Strength Index) can also come in handy.
The ADX and RSI can help you determine the strength or magnitude of a trend at any point. These indicators can help you determine whether you want to go short.
While most traders will sell a downtrend and continue profiting, some traders usually take different approaches.
Experienced investors use a downtrend to look for a buy; after all, the price will go as low as possible. And a bounce back can guarantee you a huge profit, especially if you enter at the lowest price.
Example of a Prolonged Downtrend
A prolonged downtrend means the stock’s price constantly decreases for several months. Lower troughs and lower peaks characterize prolonged downtrends. Remember, when the price continues dropping, then it can serve as a sign of negative sentiments in a market.
A prolonged downtrend of a company’s stock price confirms that the company may be in trouble. When a company experiences product cancellations, spinoffs, layoffs, and plant closing, it can experience a downtrend.
These activities can serve as a confirmation of an unexpected change in the economic environment of a company. In a downtrending chart, the stock can finally peak when the trend changes before dipping into a prolonged decline. The first lower trough will symbolize the moment sellers overpowered the buyers.
But if the company is underperforming, some negative news like layoffs can seal the deal. Some negative information about the company can help the investors determine the firm’s status and go short.
Further confirmation of the downtrend can be some lower troughs and peaks, which will show that the downtrend will last. So if you went short after the first trough, you would be in a position to benefit from several profitable trades.
On the other hand, long traders can lock their profits and enter a new long position after noticing the rebound. In a prolonged downtrend, investors will never look for a buy position.
After all, a buy position can be risky, especially if negative new information has been released and the company is not doing well.
So if the stock is in a downtrend in a positive market, then there could be something wrong with the company. It can be an indicator that you should do more research before getting into any position. [no suggestion by keyword planner]