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Fundamental & Tech Analysis
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How to Draw Trendlines

The trend is your friend

Let’s talk about trends and trading. When it comes to the stock market, technical analysis is a method for judging stocks based not on news, reports or even value, but on chart-driven data that shows precisely  — well, almost precisely — what the price and volume of a given share has been over time.

If you’re looking to learn technical analysis learning how to spot a trend is paramount. In this posting, we’ll start by considering what a trend is, and how to recognize it, and then we’ll turn to some basic tools for making your own charts.

Trends: 3 types and how to spot them

 

Ever tried downhill skiing on an ungroomed slope? Athletes will tell you it does two things to the run: it makes it nearly impossible to do anything other than react to the poor conditions under boot, and it chews the heck out of the surface of your skis.

 

There’s a reason skiers like a fresh-powder slope. It allows them to use their skills, to perform progressively rather than reactively, and because it’s the environment in which amazing things can happen.

 

Think of the stock market in a similar way: trying to trade without understanding trends will rob you of opportunities to make graceful moves, to look ahead and anticipate what’s upcoming. You’ll be reacting the whole time and chewing up your assets — money rather than skies — in the process.

 

So, how do you know if you’re seeing an upward or a downward trend, and not just another range of up-and-down trading? In the examples that follow, we’ll look at Lilo Chemicals, a fictional manufacturer of materials for the bio-tech industry.

 

  • Upward Trend: Say that on Day 1 of a six-day period you find Lilo trading at a price of $113. Day 2 brings a price of $115. The next four days: $114, $117, $115, $119. The key indicator here, the one that tells you Lilo’s on an upward trend (or an uptrend): after each increase there’s a dip, but the decrease never drops the stock lower than the previous low.
  • Downward Trend: Alternatively, Lilo could look like this over six days: $125; $127; $122; $124; $120; $123. Here, the downtrend behaves in a way opposite the uptrend we just looked at: each dip is lower than the ones before (and in this example, each high is lower than preceding highs as well).
  • Sideways Trend: Say, however, that Lilo had done the following: $113; $115; $114: $113; 115; $114. Is it going up or down? Neither. This is a horizontal or sideways trend.

Trend times: short, long, and intermediate

 

Each of the examples above are what traders would call a short-term trend, a period of less than a month.

The longer the trend, the more it means to a trader seeking confidence in a stock. For example, a trend lasting a year has much more significance than a trend lasting a week.

Making a trendline: how to anticipate stock changes on a chart

 

If you put a stock’s performance on a chart, in its most basic incarnation, it will look like a rising and falling line. Using the “yardsticks” for identifying trends that we’ve just considered, you’ll get better and better with practice at identifying uptrends, downtrends, and so on. And once you do so, you can begin to see the potential beginnings of new trends. The key tool that comes into this: the trendline.

 

In it’s most simplest for, trendlines can be as simple as drawing a straight line that touches all the low points (or the stock’s support levels) on an uptrend, or all the high points (called resistance) on a downtrend. If you draw both trendlines, that’s a channel. 

 

Now, if you see a stock break its support or resistance levels, then you may be watching the beginning of a new trend altogether. In many cases, traders like to get in, or out, at the start of a new trend — the idea is to take a ride up or unload shares before their price dips very far.

Later in this series on technical analysis we’ll look deeper into trendlines. At this point, take on the basics, and get familiar with the process. And happy charting, traders!

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