Trends vs. Trading Range

Before you enter a trade on any equity, you want to have some idea of how that stock (or index, or exchange-traded fund) can be expected to move. Here, we'll examine a few common patterns to help you identify an equity's trend, and how to help you spot a range-bound stock.

Trends

A stock's trend can be identified in a few different ways. First, by simply eyeballing a daily, weekly, or monthly chart of the equity in question, notice the pattern of the peaks and valleys. Is the stock forming a series of higher highs, punctuated by a series of higher lows in between? This stock is in an uptrend, as its movement has created a stair-step effect on a path higher.

This same pattern, when inverted, can signal a downtrend for an equity. That is, if a stock is forming a series of lower highs and lower lows, it has established a downward-sloping trend.

However, this simple assessment is not the only way traders can identify a trend. A common way for investors to determine a stock's direction is through the use of moving averages. A moving average is simply a trendline that reflects an equity's price movement over a given period of time – whether daily, weekly, or monthly. Since a moving average is calculated from the stock's historical performance, it can often be a reliable indicator of the stock's future direction.

For example, a stock that is ascending along the support of an intermediate- or long-term moving average can often be expected to continue along that path higher. One caveat to keep in mind when using moving averages to spot a trend is that the more times a supportive moving average is tested, the weaker it can become. The same general rule holds true in reverse – the more times a stock rises to challenge a resistant moving average, the weaker that resistance becomes.

Depending upon the type of trade you're trying to execute, you may be better served by analyzing short-term or intermediate-term moving averages to spot your trend. Additionally, you can use different time intervals to target a key entry or exit point in a trade – the 50-day moving average is relied upon by many traders for this purpose.

Trading Range

Now that we've discussed uptrends and downtrends, only 1 type of trend remains: the sideways trend, or the so-called trading range. This pattern occurs when a stock experiences some up-and-down movement, but no definite trend to the upside or downside presents itself. Therefore, while the stock may have a good day where it adds 5%, it could lose 1% over each of the next 5 trading days to end up back where it started.

Trading ranges are not necessarily a bad thing. A stock can enter a trading range as part of a period of consolidation before rallying higher. In fact, this is frequently the case when an equity has gapped above support from an intermediate- or long-term moving average. The stock will edge sideways until its trendline can catch up to its movement, then a boost of support from that moving average will launch the stock higher.

However, the sideways trend can also be a terminal illness. Some stocks will languish for years in a channel between two key levels of support and resistance. These levels can be represented by round numbers or by moving averages, or they can appear quite arbitrary. For whatever reason, these equities lack the momentum to snap out of their trading range in one direction or the other. These are sometimes referred to as range-bound stocks.