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Reading trend lines is another important part of technical analysis after mastering support and resistance.
Now, I want you to google and learn the basic stuff about trend lines and how significant they are while predicting the market movement. Also learn a thing or two about trend line breakout and how to utilize it to make money.
After the basic stuff, this article will help you sharpen your basic knowledge about trend lines. The points mentioned here will also increase your efficiency since these tips are not commonly talked about by others.
Basic tips about trend lines
a) The strength of a trend line depends on the number of pivot points. A point point is a point from which the trend reverses. Thus, the tops and bottoms seen in a stock chart are pivot points.
b) The strength of a trend line depends on its length. However, the number of pivot points is of more significance than the length. A trend line is still strong if it has more pivot points in a short length.
c) Steep trend lines are less credible. A trend line should have a “healthy” slope, and not be overly steep. Steep price movements are caused by irrational optimism or excess fear.
Important tips about trend lines
- A breakout is confirmed if the stock price closes 3% above or below the trend line.
- However, less leeway can be allowed for a sector chart. In a sector chart, a 2% breakout is also considered sufficient.
- An upside breakout needs enough volume confirmation. However, volume confirmation isn’t necessary in a downside breakout.
- If the stock wanders less than 3% up or down a trend line that is formed by joining only two pivot points, you may redraw the trend line by joining first and the new pivot points. Thus, the movement is not a breakout but a redefinition of the trend line.
- If the stock explores less than 3% up or down in a trend line formed by joining more than two pivot points, you may ignore the erratic behavior and retain the previous trend line.
Trend Channel
One can draw a trend line by either joining the tops or the bottoms.
- In an uptrend, the trend line joining the bottoms is more significant. The other line joining the tops is called the return line.
- In a downtrend, the trend line joining the tops is more significant. The other line joining the bottoms is called the return trend line.
- However, the return line is also important because the margin by which price fails to reach it is the margin above or below which the stock will violate the trend line.
The tunnel or cylindrical area formed between the trend line joining tops and the trend line joining the bottoms is referred to as a trend channel.
Trend channels are important because a stock tends to move within this tunnel until it breaks out and moves in another trend channel formed by a new set of highs and lows.
Note that a trend line should not be rigid. It should just join the high and low area in a way that represents the trend direction while incorporating as many pivot points as possible.
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