The last thing you want to do when trading on the stock market is buy shares in a downtrend (DT lines). Stocks should not be purchased while they are rising, which is even more true when they are falling, since if they are trapped under the downtrend, you will be in for some very rough times.
For example, although the energy sector saw some gains and showed several uptrends in 2016, the vast majority of stocks in the sector stopped rising late in 2016 and then began a well-defined downtrend. Vermilion (TSX VET) and Tourmaline (TSX TOU), for example, did not show any valid buy signals until very recently. Every time these stocks crossed through important support levels (S lines), they then continued their falling trend for a while. These stocks will only become attractive again from a technical standpoint if they halt their bearish trend to move horizontally between a support (S) level and a resistance (R) level, which means a neutral trend. However, this does not necessarily represent a buy signal. For that, stocks must begin an uptrend (UT) by breaking through the resistance level for the neutral trend.
Spotting the changeover from a bearish to a bullish trend
Although the vast majority of stocks in the energy sector saw a downtrend in 2017, they did not all follow the trend at the same time and will also not begin to rebound at the same time. As you can see in the graphs, Trilogy began its new uptrend in early August and began a second straight upward cycle in mid-September 2017. Meanwhile, Vermilion was reversing its neutral trend and beginning its first rising cycle. Note that over this period, Tourmaline shares fluctuated within a neutral trend without reversing anything yet.
Change in the short of a share (top) and the volume of transactions made on the share (bottom)
Paramount Resources TEC Ltd (TSE:TET)
Tourmaline Oil Corp (TSE:TOU)
Vermilion Energy Inc (TSE:VET)
Picking the leaders
When an entire sector is in a downtrend, you can expect the downtrends to eventually change into neutral trends. However, certain stocks will be ahead of the pack: these are the leaders, the first wave of bullish signals. If buyers continue to rush in, other stocks will launch into a rising cycle in the next few days and then the sector will experience a new rising trend.
Self-directed investors are often too late reacting to such situations. Typically, when the first stocks take off, investors watch their movement from the sidelines the first day or two without buying. On the third day, when stocks from the first wave have been going up for three days and stocks in the second wave have been going up for two days, they will buy stocks in the third wave, which are starting a rising cycle and an uptrend that day, believing that they will rise as much as the others. In reality, they are buying the stragglers. If the stocks in the first wave stop rising or begin to fall back, those in the second and third wave will follow suit. That’s why it’s crucial to buy stocks in the first wave, the leaders.
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Edited on 25 September 2017