Technical traders know that to generate consistent gains, trade in the direction of the primary or underlying trend. The best way to identify the direction of the trend is by studying the price of actions over time.
Markets or securities can also trade in a directionless or erratic manner, making it challenging for traders to navigate. However, when the price shows consistent market actions, it allows traders to make informed trading decisions on the future trend.
Classic technical patterns and directional trends come in different shapes and forms, including lower-highs and lower-lows (downtrend), lower-highs and higher-lows (triangle), lower-highs and higher-highs (broadening), and higher-lows and higher-highs (uptrend).
Highs and lows are starting reference points for identifying the directional trends. These reference points are useful on the shorter-term charts (i.e., daily charts). The progression of these price points can alert traders of bullish or bearish conditions. For instance, it is bullish when the price exceeds a prior high price (higher-high) in an uptrend (higher-low). On the other hand, if the market trades below a previous low (lower-low) in a downtrend (lower-high), the market trend tends to be bearish.
A market or security does not always show a clear progression of higher-highs/lows or lower-highs/lows. Under these scenarios, they may signal a period of consolidation, continuation, or neutral sideways trading ranges. For example, prices are contracting via lower-highs and higher-lows. The narrowing of the two opposing trends signals a contraction in volatility leading to an impending trading range breakout/breakdown (symmetrical triangle). When prices expand via higher-highs and lower-lows with two diverging trends (broadening pattern), this warns at rising volatility.
The divergences between market indexes can alert traders to trend changes and market leadership shifts. Positive divergence hints at bullish trend reversals and emerging market leadership. Negative divergence warns at bearish trend reversals and loss of market leadership.
Market indexes show divergences. The pivot or reference points are the intraday lows coinciding with 1/24/22, 2/24/22, and 3/8/22. The large-cap U.S. indexes continue with lower-lows trends, signaling continued selling pressures. The mid-cap and small-cap indexes show flat-to-sideways trends (consolidations). The Micro-cap ETF is positively diverging from other market indexes, evidenced by higher-lows, or buying pressures.
Although it may be too early to determine the dominant trend, the following observations are noteworthy:
The smaller-market cap markets are outperforming their larger-cap counterparts via flat-to-higher lows patterns. The divergence hints at traders finding value or venturing into the volatile and higher beta investments.
It may also convey selling exhaustions or market capitulations conditions. Washed-out sectors and stocks may attract deep value money managers, contrarian traders, or smart-money looking for opportunities.
Large-cap markets may need to fall further in line with the more severe declines of the lower quality and riskier investments.
The recent short-term rallies may be temporary and are not sustainable since the prevailing 2-plus month downtrends. The oversold rallies are dead cat bounces before the resumption next market selloffs.
Lower-lows and higher-lows only give you half of the picture. Higher highs are still necessary to confirm breakouts, solidifying the recent 1/24/22 and 2/24/22 lows major market lows.
The 2/24/22 and 3/8/22 lows are heavy volume days and signal the potential at higher-lows patterns. Although these are positive signs, time is needed to confirm sustainable trends.
Markets are currently trading below the 50-day and 200-day moving averages. They are neutral consolidation conditions or warning signs of the beginning of primary downtrends.
One or two days does not make a trend. It takes many days or weeks to confirm a trend. However, if this is the start of a sustainable uptrend or the resumption of the bull trend, broad market indexes need to show higher lows and higher highs.
Also, watch for positive and negative divergences and dislocations between market indexes and S&P sectors to signal pivotal trend changes and market/sector leadership shifts. In a bull market, trading mistakes are lessened since the bull market can bail you out. In a bear market, trading mistakes are not easily rectified. Stay disciplined and monitor key pivot points (reaction highs and lows) to determine if this is another dead cat bounce or the start of a market bottom.
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