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Investment Lessons - Lesson 1 - Technical Analysis
Trendlines - the Basics
What is a trendline?
A trendline is the simplest of all the technical analysis tools, yet one of the most effective.
In short, a trendline is a line drawn on a technical chart connecting two or more points on a price chart. Once in place, it shows the general direction of a trend of movement in prices.
Consider the following chart of the S&P 500 Index from May 1999 to March 91, 2001.
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A trendline is drawn from the low of a series of bottoms over the time period being studied. In this case, the trendline was extended to mid-October, making it a long-term trend.
When any trendline is crossed, it is said to be violated. Although this trend had a few minor crosses near June 1, the long term was not violated until September of 2000. At that time with the index at around 1450, it began a steady decline.
Now, let's look at Chart 2, which is the same chart as before, but instead showing a down trendline.
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The peaks of mid-August are connected to the high of early November to illustrate the down trend, and this line is extended to mid-March of 2001.
A downward sloping trendline joins the highs of a series of declining prices.
The violated uptrend saw the index fall from 1450 to a low of around 1230, and then a modest upside rally before settling back down around 1230, a drop of nearly 220 points in the index. That represents a decline of just over 15%.
Trendlines are developed in three time frames: short term, intermediate term, and long term. The use of proper timing of these lines will be discussed in Lesson 3.
Applying the use of trendlines to your retirement accounts is easy. Suppose you have money invested in the S&P 500 index. If you remained invested in the index until the long term trendline was violated, and then switched from the S&P Index to a money market fund, your accounts would have avoided a 15% or more decline in the index and could have earned the interest rate being paid in the money market account.
Remember that your mutual fund or sub-account must remain fully invested in stocks or bonds that meet the fund's objective. In this case, the manager of the S&P 500 must remain invested in the stocks comprising the index, no matter whether the market trend is down or not. The fund manager cannot change the direction of the market.
You, however, have the opportunity to move from account to account as market conditions indicate. So even though you cannot change the trend of the market either, but you have the ability to allocate your assets in such a way as to minimize the market's impact on your account.
It is this type of information that profitsharing.org provides for you in the form of education and alerts based on this technical analysis.
Technical analysis is sometimes called the single best 20/20 hindsight of what the market has done. To a degree, this is true. If one looks at a chart of prior prices, each technical system looks like a winner. Irrespective of some opinion, technical patterns do start to set-up early, and provide signs of market movement.
By itself, a trendline is not the most important tool in the technical arsenal. Used in conjunction with other indicators, however, it is a powerful tool.