The Downtrend

A downtrend occurs when stock prices trace lower highs and lower lows. We can sometimes add a falling trendline to a chart by linking the high points.

As soon as we have two consecutive highs we can join them to make an unconfirmed falling trendline.

For the trendline to be confirmed, and hence validated, the price chart must respect it by rebounding from it a third time.

Confirmation of a falling trendline is a powerful sell signal.
After confirming a falling trendline, we stay out of the stock for as long as the share price stays below the trendline.

Many investors are attracted to stocks whose price is falling. These investors are in search of a bargain - a natural human instinct.

O'Shaughnessy* found, however, that a strategy of investing in stocks whose price had fallen significantly resulted in poor returns compared with other strategies.

It is preferable not to buy a stock whose price is in a downtrend. Wait for an indication the downtrend is over.

For some, the end of the downtrend might be signaled by a trendline break, shown in the chart on the right.

Others prefer to buy only after an uptrend has been confirmed. In the charts shown on this page, although an uptrend follows the downtrend, the uptrend is not confirmed.


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