A downtrend refers to when the price action of a [financial instrument] moves to a lower price point over time. The price may fluctuate upwards and downwards during this time, but a downtrend occurs when these fluctuations amount to have a decline in the price overall throughout the time frame.
Traders seek to distinguish downtrends from random downward price movements as the trend suggests that there is a significant likelihood that the price of the instrument is likely to continue moving downwards and that they should move to a [short position]. In contrast, an [uptrend] is observed when price action is experiencing an overall upward trend throughout the time frame.
Traders will often look for turning points in price action known as swing highs or swing lows, which may demonstrate that the price of an instrument is reversing. At these points, they would look to enter a trade in the opposite direction. For the trader to be convinced that the price was beginning to reverse, they would need to observe a significant change in the underlying market conditions of the instrument.
Traders will utilize technical indicators to help confirm if a downtrend is taking hold. One major indicator to help with this is the [moving average], which can be applied over various time frames. If the price is below the moving average, it often confirms that an instrument is in a downtrend, with the reverse being true for an uptrend. Other indicators that may be used to help confirm a downtrend are the average directional index (adx) or the relative strength index (rsi).
Key takeaways:
- A downtrend is used to describe when the price of an instrument moves in a prolonged downward direction
- Traders seek trends and turning points to decide the types of orders they should place.
- If the price is demonstrating lower highs & lower lows, then a downtrend is often confirmed.
- Traders will often use technical indicators such as moving averages or rsi to help confirm that a downtrend is in place.