A downtrend is a sustained decrease in price over time, which is created when bearish traders (sellers) take control of a market. The chief characteristic of a downtrend is a step-like descent of candlesticks or bars making lower highs and lower lows.
Technical analysts will attempt to identify a downtrend because they’re more significant than a temporary decline in price. Downtrends are usually spurred on by changes in the valuation of an asset, whether that’s as a result of macroeconomic factors, technical indicators reaching key levels, negative news, or disappointing company earnings. These can have a lasting impact on the market price.
While most traditional trading takes place within an uptrend, you can go short on market prices with derivatives, enabling you to take advantage of downtrends.
You can spot a downtrend by focusing on changes in momentum within an uptrend. Put simply, is there strength behind a trend. The change from an uptrend to a downtrend isn’t normally instantaneous but instead often happens gradually as bullish momentum subsides, and bearish pressure grows. You can use momentum indicators such as the Relative Strength Index (RSI) and Moving Average Convergence Divergence (MACD) to identify when momentum is rising or falling.
The first sign that a market is heading for a downturn is that the price falls below the previous low and fails to rise higher than the previous high. The bearish pressure will cause lower lows and lower highs, breaking through major support levels.
The first sign a downtrend coming to an end is when you start to see higher lows and higher highs. This is seen on candlesticks in a pattern known as a double bottom, where the second bottom is slightly higher than the first. Then, if the upward move breaks the previous high, there is a high chance the bearish trend is about to reverse.