It is common sense to buy something when its price is low and sell when the price is high. Technical analysts would tell you that in case of stocks, this statement is not true most of the time.
Trends in The Stock Market:
When the price of a stock keeps going up, it is said to be moving in an uptrend. It does not mean that it keeps on rising without any fall. It is just that when it is rising, it is making higher highs and when it is falling, it is making higher lows.
When the price of a stock is moving downward for a considerable period of time, it is said to be in a downtrend. Here again, it may not be a freefall. When the prices of down trending stocks rise, they make lower highs and when the price falls, they make lower lows.
When the price is not following a particular direction and is hovering around a particular point, it is said to be in a sideways trend. A trader cannot trade in this stock because of the lack of sufficient movement in the price.
The 2 Important Terms - Support & Resistance in Technical Analysis Stocks
A stock may be falling but when it touches the ‘support’ level, the stock is at price where buying emerges preventing a further fall in the stock. However, if the price breaches this support level, a further fall can be expected. Similarly the price of a stock may be rising but when it touches the ‘resistance’ level, sellers come in. The increased supply of shares checks a further rise in price. If the price goes beyond the resistance level then the upward trend will continue.
Support & Resistance Levels To Trade Down Trending Stocks
A trader can profit from down trending stocks by either shorting the stock futures or by selling the stock if he possesses it.
- When down trending stocks pullback i.e. the price starts moving up after a fall, then one has to wait and short or sell the stock when it reaches the resistance level. This is because technically, the stock will touch resistance and fall. However, this may not always happen and if the stock breaches resistance, there may be a trend reversal which means that the downward trend will stop and an upward trend will begin. This will result in a loss to the trader. So to minimize loss, a stop loss has to be placed just above the resistance level.
- Another way to trade down trending stocks is to sell or short the stock when it breaks through the support level. Stocks usually touch support levels and bounce back. But the down trend may be so powerful that no buying emerges at the support level causing the stock to fall even further. Again, there is no guarantee that the price will keep on falling and it is advisable to place a trailing stop loss.
The low prices may tempt one to buy down trending stocks but it is better to desist from buying these stocks. The prices of these stocks could be falling due to a reason one may be unaware of and buying should wait till one can see a firm uptrend. ‘Cheap is not always best’ and ‘picking the bottom’ may sound good in theory but is not easy at all. The investor or trader may just end up buying a stock which still has room to fall.
Professional traders don’t buck the trend; instead they follow the policy –‘Make the Trend Your Friend’.