Peak-and-Trough Analysis

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Peak-and-Trough Analysis

Peaks and troughs are patterns that emerge from the price behavior of all assets. Prices, as we all know, seldom travel in straight lines, whether in an uptrend or a fall. Many charting software applications will offer a “%-zigzag” indication that investors may put down on a chart that they are seeing.

Key Takeaways

  • Peaks and troughs are patterns that emerge from the price behavior of all assets.
  • The breakdown and replacement of either rising or falling peaks and troughs is the simplest approach to identify whether or not a trendline has been broken.
  • To spot this sideways pattern, we need be mindful of consolidation in the analysis of peaks and troughs, avoiding the error of assuming the current trend is set to reverse.

The Ups and Downs of Peaks and Troughs

Rising peaks and troughs may be readily seen on a chart by identifying the higher peaks, or tops, and higher troughs, or bottoms, which form the uptrend. Another way to look at it is that each new peak formed by price movement is higher than the preceding few days, weeks, or even months of trading. Furthermore, each new low would be greater than the prior trough during the same time span.

Image by Sabrina Jiang © Investopedia2021

Up arrows indicate increasing troughs and down arrows indicate rising peaks in the above chart of PepsiCo, Inc. (PEP). From the middle of December 2001 to the third week of April 2002, the stock price rose from roughly $46.50 to $53.50, a 15% increase excluding fees.

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Breaking Trend

The breakdown and replacement of either rising or falling peaks and troughs is the simplest approach to identify whether or not a trendline has been broken. Given the importance chartists put on the psychological components of technical analysis, some technicians may believe that this tried and true technical indicator outperforms most, if not all, trend-following approaches. Investor confidence and an optimistic view of a given issue’s future propel stock prices upward, whereas lack of confidence causes even the most tenacious issues to begin a downturn.

The Rule of Thumb

To spot this sideways pattern, we need be mindful of consolidation in the analysis of peaks and troughs, avoiding the error of assuming the current trend is set to reverse. As a general rule, consolidation will take 33-66% of the time span of the prior trend. But don’t let this guideline replace the common sense and knowledge that comes with long-term investment.

At the same time, peak-and-trough research is a strong, no-nonsense method to trend analysis that should not be overlooked in the quest for the market’s bottom and subsequent reversal. When circumstances are difficult, investors should examine peak-and-trough analysis of their own concerns and, using a moving-average indicator, start looking for what may be a significant reversal for some of their battered issues. However, you must be cautious not to choose a time limit that is too short. Peaks and troughs form over weeks and months of price activity, rather than hours and days of trade.

Conclusion

Keep in mind that price movement consists of rallies and subsequent responses. Also, keep in mind that the time period of the rising peaks and troughs (or falling peaks and troughs) defines the strength of the trend, and that general market confidence (or lack thereof) will reverse a trend quicker than any technical analyst signal.

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