Saturday, January 8, 2011
PART II: CHART PATTERNS
10. TREND LINE
Trend line analysis is probably the oldest and simplest chart reading method. Trend Lines are an important tool in technical analysis for both trend identification and confirmation. It was first used in Holland hence it is also referred as a Dutch Line.
DRAWING A TREND LINE:
A trend line is a straight-line that connects two or more price points (usually two tops or two bottoms) which then extends into the future to act as a line of support or resistance. The general rule in technical analysis is that it takes two points to draw a trend line and the third point confirms the validity. Many of the principles applicable to support and resistance levels can be applied to trend lines as well. Trend lines can be classified into two categories.
1. Uptrend Line
2. Downtrend Line
An uptrend line has a positive upward slope and is formed by connecting two or more low points. The second low must be higher than the first for the line to have a positive slope. Uptrend lines act as support and indicate that net-demand is increasing as the price rises. As long as prices remain above the trend line, the uptrend is considered solid and intact. A break below the uptrend line indicates that net-demand has weakened and a change in trend could be imminent.
A downtrend line has a negative downward slope and is formed by connecting two or more high points. The second high must be lower than the first for the line to have a negative slope. Downtrend lines act as resistance, and indicate that net-supply is increasing as the price declines. As long as prices remain below the downtrend line, the downtrend is solid and intact. A break above the downtrend line indicates that net-supply is decreasing and that a change of trend could be imminent.
* To enlarge the chart Double click by keeping the cursor above the chart.
The lows used to form an uptrend line and the highs used to form a downtrend line should not be too far apart, or too close together. An ideal trend line is made up of relatively evenly spaced lows (or highs).
A famous quote about trends advises that "The trend is your friend". For traders and investors, this wisdom teaches that you will have more success taking stock positions in the direction of the prevailing trend than against it. Trends tend to persist over time. A stock in an uptrend will continue to rise until some change in value or conditions occurs. Declining stocks will continue to fall until some change in value or conditions occurs. Chart readers try to locate TOPS and BOTTOMS, which are those points where a rally or a decline ends. Taking a position near a top or a bottom can be very profitable.
Trend lines can offer great insight about the future but, they can also give false signals at times. Trend lines are merely one tool for establishing, and confirming a trend. Trend lines are merely used as a warning that a change in trend may be imminent. By using trend line breaks for warnings, investors and traders can give closer attention to other confirming technical signals for a potential change in trend.