A trendline is drawn on a stock chart and defines direction of trend which may be up or down. The lines are connected through critical price points to smooth out the volatile nature of the stock’s price action. The lines are visual representations that generalize the market direction. A trendline is a technical analysis concept which are basically diagonal support and resistance lines.
How To Draw Trend Lines
To draw a downward trendline, you connect the points that form “lower highs”. See example above. The key is to keep all price action below the line. Likewise when drawing a trendline that is upward, you should connect the price points that are “higher lows”, and keep all the price action above the trendline.
Trends can be found within trends. If you look at the chart above, there is smaller trendline drawn above the major lower trendline. This could be considered an intermediate trend. This is useful for those stock traders that focus on shorter term trading strategies.
To get a feel for drawing a trendline, it takes just a little practice. Take time to review different stock charts in different sectors. Learn to analyze the trends of other markets like futures, currencies, and bonds. By doing so, it will give you an idea what stage the market is currently in. Explore the different charting services online. There are many charting services that are free, and many brokers offer offer free charts if you just open an account.
A Trendline Can Analyze any Market: The chart above is an ETF that tracks the S&P 500 index. You can apply a trendline to an individual stock, commodity, or currency chart to get an idea of the market direction. This tool is universal in trading all financial instruments, and is simple to learn.
Trade with the Trend: As a general rule, when you analyze a stock and are thinking of going long or buying the breakout, it is mandatory that you get an idea of what kind of trend the general market is in. You would also check to see if the Dow Jones or Nasdaq indexes are in an uptrend by drawing a trendline on the Dow Jones chart. You want to be “congruent” in your trading. Would be a terrible mistake to buy breakouts while the major market indexes are in a downtrend. Many traders make this mistake. You don’t want to go against the tide. It’s a matter of statistical probability that your chances of a profitable trade are higher if you go with the trend of the market.
A Trendline Can Trigger A Sell Signal: One of the hardest thing to do when learning how to trade stocks, is knowing when to sell. Often times traders make a great buy only to hold on till it becomes a loss. The key is to take profits when the trend comes to an end. Because you have defined a trend, if the stock price drops below the upward trendline, you can safely say the the stock’s trend is over and sell immediately without second guessing or hesitation.