Stocks & Commodities V.

6:5 (196-196): Trend detection by Arthur Merrill

Trend detection
by Arthur Merrill

T he trend of prices is itself an indicator of the future, since trends tend to continue. In a bull market,
the major trend is upward. Since most stocks ride with the trend, it's a good idea to buy and hold stocks in
a bull market. The reverse is true in a bear market.
But the movement in a bull or bear market certainly isn't a straight line. There are secondary reactions in
bull markets when the intermediate trend is downward. There are rallies in bear markets when the
intermediate trend is rising. Within these intermediate trends there are minor reversals, forming minor
trends.
It pays to invest in the direction of a trend. But how do you determine this direction? Here are a few
methods:
• The eyeball method: A glance at a chart can be revealing; the trend is sometimes obvious. As Yogi
Berra put it, "You can observe a lot by watching." If the trend isn't obvious, one of the more objective
methods is preferable.
• Filtered waves: This method is simple—minor reversals are ignored or filtered out. A trend is assumed
to continue until an important reversal comes along. This is the method used in point-and-figure
charts. Prices continue in a fixed direction until a reversal of a stated number of points occurs.
I prefer to use a percentage rather than a number of points. For example, my definition of a bull or bear
market is any swing of more than 30% (Figure 1). All swings of less than 30% are ignored; what remains
are bull and bear markets. This definition fits the financial histories quite well.
In using percent reversals, be careful where you put 100% (Figure 2). A downswing of 10% is greater
than an upswing of 10% if you make 100% the beginning of each swing. To make the upswings and
downswings comparable, use the bottom of the swing as 100% in both upswings and downswings.
Of course, the filtered wave method is late, like all trend-following methods. You don't know you're in a
uptrend until sometime past the bottom.
• Zigzag direction is the method used in the venerable Dow Theory. Are past high points being
penetrated upward to make new high points? Are prices dropping through previous low points to make
new lows?
Reversals of trend are defined by support and resistance violations (Figure 3). A breakthrough by the
Industrials Average must be confirmed by a breakthrough by the Transportation average to validate a
change in the trend.
• Trendlines is a method closely allied to zigzag direction. Trendlines are often drawn through low
points to define an upward trend. Violation of that trend line signals a change to a downtrend (Figure
4). Similarly, trendlines are drawn through the tops of rallies to define a downtrend. Violation of the
line signals a trend change to the upward direction.
In stock price charts, true trendlines should be drawn only on a chart with a logarithmic scale (Figure 5),

Article Text Copyright (c) Technical Analysis Inc. 1

Stocks & Commodities V. 6:5 (196-196): Trend detection by Arthur Merrill

since the stock prices are better analyzed on a percentage basis. In your work, a move from $120 to $100
should be the same as a move from $12 to $10.
There are more ways of determining a trend: we will continue this subject next month.
Arthur Merrill is widely known for his long-running Technical Trends , a graphical report focusing on
indicators and growth companies.

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Stocks & Commodities V. 6:5 (196-196): Trend detection by Arthur Merrill

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