Downtrend

Updated on May 3, 2024
Article byRutan Bhattacharyya
Reviewed byDheeraj Vaidya, CFA, FRM

Downtrend Meaning

A Downtrend is a gradual decrease in the value or price of a financial instrument, for example, a stock or a commodity. A downward trendline acts as resistance and signals more supply than demand for a security, even if its price drops.

Downtrend

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This trend remains intact as long as the prices stay under the trend line. A break over the line signals that a trend reversal may occur. Since a downward trend’s duration and length can vary, traders may trade this trend via a weekly, daily, or even a one-minute duration. This allows traders to generate a profit from the decreasing asset prices.

Key Takeaways

  • The downtrend definition refers to the slow reduction of an asset’s price. This trendline serves as resistance and indicates that the supply of the asset exceeds its demand. Traders can utilize the decreasing prices to make financial gains.
  • A vital difference between downtrends and uptrends in the stock market is that the former features descending peaks and troughs, whereas the latter features ascending peaks and troughs.
  • Individuals can utilize various technical analysis tools like the MA indicator and trendlines to spot a downtrend in the stock market.
  • When trading a downward trend, traders must consider placing a stop-loss order to minimize losses.

Downtrend Explained

The downtrend refers to a sequence of successive lower tops and bottoms, creating a downward pattern on a financial instrument’s price chart. It indicates that the supply for a particular asset is more than the demand even when its price is falling.

The line that connects at least two tops is the downtrend line. The more the number of tops utilized to draw this line, the more a trader has confidence regarding the downtrend as the direction is reinforced by it.  

While a security’s price may increase or decrease intermittently increase or decrease, lower troughs and lower peaks characterize such trends over time. The possibility of securities in a downward trend trending lower is high until a few market conditions change. This implies that such a trend represents an inherently deteriorating condition.

Securities changing from an upward trend to a downward trend rarely make an immediate alteration from one to the other. Rather, in an upward trend, the price action gives indications of strain. Then the downward trend starts incrementally. The swing highs or peaks and the swing lows or troughs mark the uptrends and downtrends in the stock market.

Let us look at some signs of a downward trend.

  • First, the number of sellers of a financial instrument and the quantity they wish to sell exceeds the number of buyers of that security and the quantity they wish to purchase.
  • Secondly, more and more market participants decide not to own the security. In other words, the total sellers increase while the total buyers decrease simultaneously.  
  • Finally, the last signal is often associated with new details or news that confirms the intuition of those individuals who no longer consider purchasing the financial instrument or are convinced that they will exit the market.

Below is a chart from TradingView that shows a clear downtrend. The downtrend appears with a series of lower highs and lower lows, and a parallel channel highlights it. This kind of steady movement of the stock downwards suggests that there is some problem or negative situation regarding the stock or company. The investors do not want to invest their money in this organization, and they are selling out. However, a group of smart traders may use this opportunity to make profits by taking short positions. However, it is risky, and they need continuous monitoring along with a proper stoploss in place in case there is a reverse trend. 

After that, there is a consolidation phase for the stock, which is quite common in such cases, and then the downtrend resumes again. It  easy to conclude that for this share, the bears are completely in control and are successfully creating a situation where investors have lost faith. 

Downtrend Graph

Source

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How To Identify?

As noted above, a downward trend is a number of lower tops and bottoms. When traders or technical analysts draw a trend line from a swing high and connect it to the next lower swing high, they can see the trend clearly. Individuals can extend that line to determine the stock’s estimated prices or values into the future.

Another technical analysis tool that one can use to identify a downward trend is the moving average (MA) indicator. It considers the mean of a security’s prices over a duration in the past. If an asset’s price tends to remain below the MA, it indicates that it is in a downward trend.

How To Trade?

Trends occur across different assets and durations. One can trade a downward trade over long durations (weekly, daily, and monthly price charts) or/and on short-term charts. Individuals must remember that the same concepts are applicable when looking at weekly or one-minute charts. When viewing the latter, traders take trades to capture the small trends that last seconds, minutes, or hours (rare). On weekly price charts, traders look for trades that could continue for years or months.

After downside impulse waveforms, a downtrend is likely to start. Hence, if a correction towards the upside occurs, it may not rally up to where that impulse wave began since corrective waves are typically smaller. Traders can opt for short selling when the corrective wave occurs, assuming that the asset’s price will have one more impulse wave lower.

There are various techniques that individuals can utilize to enter a trade when a corrective wave occurs. The Fibonacci retracement levels can help traders isolate the areas where the correction will likely end and reverse. Another technique involves waiting for the rallying of the correction to end, letting the asset’s price move sideways, and entering the trade before it begins dropping again.

Traders must place a stop-loss order on every trade for risk management. Moreover, they must have an exit strategy to take profits. If they place this order with their broker, they can sell a security when its price reaches a certain figure.

Examples

Let us look at a few downtrend examples to understand the concept better.

Example #1

Before the end of October 2022, Bitcoin remained the top cryptocurrency in terms of market value. That said, it stayed under 20,000, reflecting the most prolonged duration since surpassing that level in 2020.

Afterward, the continuous downtrend spelled pessimism among the various Bitcoin holders as the digital asset’s trademark volatility dissipated in the face of a detected recession. Moreover, the disappointing Q3 2022 was a precursor for difficult times for the cryptocurrency, as the experts cited the possibility of a fresh impact on the asset’s outlook.

Example #2

Suppose Michael Kent is an investor who held shares of ABC stock. The stock was in a downtrend for over a month. The price chart revealed that the organization’s issues were deeper than initially anticipated. The spinoffs, layoffs, product cancellations, and plant closings indicated a significant change in the economic climate that the company was not ready to deal with. After analyzing the stock, Michael realized that the price might decrease further. As a result, he sold the shares to minimize his losses.

Chart

Let us look at this downtrend chart to understand the concept better.

Downtrend Chart

As one can observe, the above index comprising India’s top 50 companies in terms of market capitalization is in a downtrend. The trendline is sloping downwards with a sequence of descending troughs and peaks. A sustained downtrend over the long term can indicate an economic contraction.

Downtrend vs Uptrend

Individuals new to trading must understand the differences between downtrends and uptrends, as these are two basic concepts of buying and selling financial instruments. Not understanding the differences will prevent individuals from capitalizing on short-term profit-making opportunities in the market. So, let us look at their distinct characteristics.

DowntrendUptrend
A downward trend has descending peaks and troughs.An uptrend has ascending peaks and troughs.
It involves a gradual reduction in an asset’s price.An uptrend refers to a gradual increase in a security’s price.
When a security is in a downward trend, it means that the supply of the asset is more than its demand in the market.If a financial instrument is in an uptrend trend, the demand for the asset exceeds its supply in the market.

Frequently Asked Questions (FAQs)

1. What to do in a downtrend?

Traders may be able to minimize losses if they choose to sell a stock that is declining in price. That said, other traders aim to generate from a downward trend by short selling or buying a financial instrument at an enticing valuation. Individuals can spot such a trend via multiple technical analysis forms.

2. Is the downtrend bullish or bearish?

When a stock market is on a downward trend, it is known as a bear market. On the other hand, when a market is on an uptrend, it is called a bull market.

3. How do you profit from a downtrend?

Let us look at some ways to profit in a bear market.
– Deal short ETFs (exchange-traded funds)
– Opt for short selling
– Trade currencies
– Go long on defensive stocks
– Trade options
– Buy at the bottom
– Invest in dividend shares with a high yield
– Trade safe-haven assets

4. What is the bullish pattern in a downtrend?

A bullish engulfing pattern typically appears in a downward trend. It refers to a combination of a dark candle and a subsequent hollow candle that is larger in size.

This has been a guide to Downtrend and its meaning. We explain it with its chart, how to identify it, comparison with uptrend, how to trade it, and examples. You can learn more about it from the following articles –

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