Identifying Downtrends

Identifying Downtrends

A downtrend is the opposite of an uptrend — the stock's price is generally declining over time. Recognising a downtrend early can save you from buying a stock that is likely to continue falling, or help you decide when to take profits on a stock you own.

The Pattern: Lower Highs and Lower Lows

A downtrend is defined by:

• Lower highs — Each rally or bounce fails to reach the level of the previous peak. Buyers are getting weaker.
• Lower lows — Each decline pushes the price below the previous bottom. Sellers are in control.

This creates a descending staircase pattern on the chart, moving downward and to the right.

Drawing a Downtrend Line

To visualise a downtrend, draw a line connecting two or more of the lower highs. As long as the price remains below this descending line, the downtrend is intact.

When to Be Cautious

If you see a stock in a clear downtrend on the NSE, consider these points:

• Avoid trying to catch a falling knife — Just because a stock has dropped does not mean it is cheap. A stock at KES 30 that was once KES 60 could still fall to KES 15.
• Look for the reason — Is the company facing real problems (declining profits, management issues) or is this just market sentiment? Check the fundamentals.
• Wait for confirmation — Before buying a stock in a downtrend, wait for signs that the downtrend is ending: a higher low followed by a higher high.

The trend is your friend — until it ends. Never fight the trend. If a stock is in a clear downtrend, patience is often more profitable than action.

Downtrend Reversal Signs

A downtrend may be ending when the price breaks above the descending trendline, forms a higher low, and then makes a higher high. Volume often increases during the breakout, showing that new buyers are stepping in with conviction.