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Investment Lessons - Lesson 2 - Technical Analysis
Trendlines - Intermediate Concepts
In Lesson 1, we learned the simple basics of a trendline.
In this lesson, we will talk more about trendlines, and how to interpret them.
We know that when prices cross a trendline, the trend is violated. That is true in both up trending and down trending markets.
When a trend is violated, it represents a change in direction. The change could be a result of short or intermediate market conditions, economic conditions, or a combination. In any event, it is a change of trend, and this is what we are concerned with.
The lowly trendline can give us many more bits of information, however, each of which helps us with recognizing chart patterns.
There are some basic rules to think about in terms of trendlines.
Rule 1
The longer the trendline is, the more significance of the trend in place.
Let's look again at our chart of the S&P 500 from April 1, 2000 to March 9, 2001.
The major down trend has been in place from September 1, 2000 until March 9. This is a six-month trend, and is indeed a significant trend. The chart has four arrows indicating points on the trendline where prices approached or penetrated the line. In January 2001, a rally broke the trendline, but the rally failed and prices fell below the trendline again.
The trendline is sloping sufficiently, that prices for the first 9 days of March 2001 are now flirting near the trendline once again. This brings us to:
Rule 2
The more frequently prices reach or approach a trendline, the more significant the trend.
In this case, so significant is this trend, that once broken and a new uptrend established, the greater the likelihood of a long trendline to the upside.
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The final rule is jus as important as the first two.
Rule 3
The sharper the angle of the trend, the less significant the trend, because the steep trend cannot be sustained.
Look at the prices of the index in the third week of May 2000, as well as the second week of July 2000. Those short-term trends were nearly 90-degree changes in price, and could not be sustained. Prices reversed in both cases. Three other occasions of similar price changes occurred during the chart period, with similar results.
Trendlines can be a powerful tool in analyzing charts, and should help you in determining when to exit and enter your funds.
Remember this important point: In technical analysis, we are looking for confirmation of changes in trend or price movement from two or more technical tools. As you study the remainder of the lessons provided, you will learn how to apply more and more tools to get the confirmations we seek.