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Trends: Two Types Or Three?

Traders know all about bullish and bearish trends. The direction of price movement is easily spotted and given technical signals and confirmation, reversal is also somewhat predictable.

A third trend beyond bullish and bearish is the consolidation, a sideways price movement.

Most traders view consolidation as a time of pause between bullish or bearish trends, in which buyers and sellers are indecisive about what happens next. However, I believe that the sideways period is a third type of trend, notable because - like other trends - it may last a period of days, weeks, or even months.

This is uncomfortable for many because without a dynamic movement in price, how do you spot reversal? There is no dynamic trend to reverse, so does this mean consolidation's end cannot be predicted? No. Some specific signals indicate the end of the consolidation trend. Most notable among these is a narrowing price range within consolidation, in the form of triangles or wedges. This narrowing forecasts breakout. Augmenting the narrowing range and breakout to follow is the Bollinger Squeeze, one of the strongest signals that consolidation is coming to an end.

Great confusion is created by the misuse of some terms. For example, consolidation is often wrongly called "continuation." A true continuation signal forecasts that a dynamic trend (bullish or bearish) is likely to continue, and is especially predictive as price moves above resistance or below support. A true continuation signal is as important as a reversal. Many candlestick signals are specifically identified as continuation predictions.

The distinction between consolidation (a sideways, range-bound trend) and continuation (a signal predicting that the current trend will not end in the immediate future) is an important one for technical analysts. Unfortunately, the confusion is widespread in this distinction.

Another error is to assume that a reversal signal appearing in the wrong place works as a continuation signal. This is misguided. A reversal only works when it appears at the end of a current trend (bullish reversal after a downtrend or bearish reversal after an uptrend). If these signals appear elsewhere, the right interpretation is that the pattern is a coincidence.

The entire science of trend analysis is a specific set of observations combining signals and confirmation, understanding statistical tendencies and probabilities, and commonsense discipline about matters like convergence and divergence, combining dissimilar signals (price, volume, moving average, and momentum), and a clear understanding of the different types of trends. It is not complicated; it is specific.

I have written a book on the topic of trend analysis, and it will be out on August 10. A Technical Approach to Trend Analysis can be pre-ordered on Amazon.com or direct from the publisher, FT Press. This book contains the following contents:

Illustration List

Introduction-Defining the Trend

Chapter 1 The Theory of Trends-Dow, EMH and RMH in context

Chapter 2 Statistically Speaking-Trends by the Numbers

Chapter 3 Resistance and Support-A Trend's Moment of Truth

Chapter 4 Trendlines and Channel Lines-The Shape of Things to Come

Chapter 5 Reversal Patterns-End of the Trend

Chapter 6 Continuation Patterns-A Bend in the Trend

Chapter 7 Confirmation Signals-Turning the Odds in Your Favor

Chapter 8 Consolidation Patterns-The Sideways Pause

Chapter 9 Volume Signals-Tracking Price Trends

Chapter 10 Mind the Gap-When Price Jumps Signal Change

Chapter 11 Moving Averages-Order in the Change

Chapter 12 Momentum Oscillators-Duration and Speed of a Trend

Chapter 13 Volatility-Marking Risk within the Trend

Chapter 14 Fundamentals-Connecting the Two Sides

Chapter 15 Overview-Putting It All Together

Endnotes

Bibliography

Index