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An Introduction to Trendlines

An Introduction to Trendlines
June 23
15:44 2011

Your eye itself can probably look at a market chart and roughly determine whether that chart has been trending upward, downward, or sideways in the near-, medium-, and long-term timeframes. However, just as there was a specific procedure to use  in high school statistics class when you were finding the line-of-best fit among a collection of data points, in technical trading analysis, there are guidelines to how trendlines should be constructed on a chart.

Typically, the trendlines used in technical analysis of market charts aren’t drawn through the middle of a set of data points, the way a statistics professor would draw a regression line. Rather, they are made by drawing a straight line through two or more significant technical price levels to establish whether the underlying market is displaying a bullish or bearish bias.

For instance, a technical trendline can be used to show a progression of steadily more bullish levels of support in a market. Support levels can be found on a chart where prices sink down to a trough, or lowest point, then rebound higher. The bottom of those “V’s” on the chart show that buyers stepped into the market at that price and “supported” it. To draw a support trend line, simply identify the latest support levels and connect them with a straight line. Especially if there are more than two support points that are nearly in line, this will show you how traders’ support for the market’s prices have been leaning.

The other kind of commonly used trendline is one that connects the technical resistance points on a chart. Resistance levels can be found on a chart where prices rise up to a peak, or highest point, then sink lower. The tip of those hills on the chart show that no more buyers could be found for the market at that price and “resisted” any move higher. To draw a resistance trend line, identify the latest resistance points and connect them with a straight line.

It’s important to note that the line you draw connecting support points might not always be upward. If the market becomes relatively more willing to sell an asset at lower and lower prices over time, the support points will trend lower. Similarly, a resistance trendline isn’t always downward – traders may grow more willing to buy an asset at higher and higher “top” prices over time, and so the resistance points could trend higher. Alternatively, there could be a stretch of time when support or resistance points remain consistently at about the same level, and the trendlines would be mostly horizontal, indicating a sideways (neutral) trend and a period of price consolidation in the market.

More in-depth study of technical analysis will improve your confidence in drawing conclusions from trendline studies. What if the resistance trendline is moving downward but the support trendline is moving up? Or vice versa? Which trendline is more important in a bullish or bearish trending market? How is the volume of trade related to the significance of the trend? Technical analysis is just a tool to analyze what the prices are telling you because an efficient market should reflect all the information known about that market in its price. Like any tool, it needs to be used properly.



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