Peak-and-Trough Analysis
Peaks and troughs are patterns that are developed by the price action experienced by all securities. As we know, prices never move in a straight line, whether in an uptrend or a downtrend. The term “zigzag pattern” has been used to describe peaks and troughs, and many charting software will have a “%-zigzag” indicator that investors can drop onto any chart they are viewing.
The ups and downs of the peaks and troughs
Upward peaks and troughs can be easily seen on a chart by recognizing the higher peaks or highs and the higher troughs or troughs, thus creating the uptrend. Another way to look at it would be to recognize that each new high created by price action is higher than the high of the previous few days, weeks or even months of trading. Moreover, each new low would also be higher than the previous low during the same period.
Image by Sabrina Jiang © Investopedia 2021
In the PepsiCo, Inc. (PEP) chart above, the up arrows show you the ascending lows and the down arrows show you the ascending peaks of this uptrend. From mid-December 2001 through the third week of April 2002, the stock price rose from approximately $46.50 to $53.50, a percentage movement of approximately 15%, excluding commissions.
Key points to remember
- Peaks and troughs are patterns that are developed by the price action experienced by all securities.
- The easiest way to determine whether or not a trendline has been broken is to witness the break and then replacement of rising or falling peaks and troughs.
- We need to be aware of consolidation in the study of peaks and troughs to recognize this sideways pattern, avoiding the mistake of thinking that the prevailing trend is about to reverse.
In the second graph, you can see the downward trend of Nortel Networks Corp. (NT) from December 2001 to the end of June 2002, and the arrows show the falling highs and lows, each breaking new ground with the previous price action pattern. In this chart, the stock price has fallen from $9.25 on December 7, 2001 to $1.50.
Breakout trend
The easiest way to determine whether or not a trendline has been broken is to witness the break and then replacement of rising or falling peaks and troughs. Since chartists place great importance on the psychological aspects of technical analysis, some technicians might agree that this proven technical indicator outperforms most, if not all, trend-following techniques. Investor confidence and an optimistic view of a particular issue’s future pushes stock prices higher, and conversely, lack of confidence sees even the strongest issues begin to trend lower.
The rule of thumb
We need to be aware of consolidation in the study of peaks and troughs to recognize this sideways pattern, avoiding the mistake of thinking that the prevailing trend is about to reverse. The general rule is that the consolidation will usually take 33-66% of the duration of the previous trend. But don’t let this rule replace common sense and investor experience that comes with investing over a long period of time.
At the same time, peak and trough analysis is a solid and pragmatic approach to trend analysis and should not be forgotten in times of finding the market bottom and subsequent reversal. When times get tough, investors should take a close look at the peaks and troughs analysis of their own issues and, coupled with a moving average indicator, start looking for what could be a dramatic turnaround for some of their beaten issues. . But be careful not to make the mistake of using too short a time frame. Peaks and troughs develop over weeks and months of price action, not hours and days of trading.
Conclusion
Remember that price action is made up of rallies and subsequent reactions. Also, recognize that the period of upside peaks and troughs (or downside peaks and troughs) determines the strength of the trend and that overall market confidence or lack thereof will reverse a trend faster than any indicator. developed by technical analysts.