If someone asked you today, “Is the stock market in an uptrend, downtrend, or a lateral consolidation,” what would you answer?
Knowing the answer to this crucial question is essential for the stock market or even an individual stock. Why? If you buy a stock (go long) in an uptrend, you are more likely to make money on it. There is a simple way to see for yourself if the market is heading upwards or downwards.
Why Draw Trend Lines on Stock Charts?
When performing the technical analysis of stocks, it is critical to understand the direction of the stock to enable you to decide if it is a candidate for purchase. Drawing trend lines enables you to visualize the direction of the stock. Additionally, stock prices breaking through trend lines can provide valuable buy or sell signals.
What is a Stock Price Trend?
The stock price trend refers to the direction the stock is moving; drawing trend lines enable you to recognize the direction quickly and be able to hypothesize on the future direction of the stock. There are three types of trend, Uptrend, Downtrend, and Sideways Consolidation. There are also multiple timeframes that must also be taken into consideration.
One Simple Rule for Drawing Trend Lines
To draw effective trend lines, you need to connect the highest highs of price together; this is the resistance line. You then connect the stock price’s lowest lows together; this is the support line. When price breaks up through the resistance line, it is a new high and a potential buy signal. When price breaks down through the support line, this could be a sell signal.
Types of Stock Price Trend
- Uptrend: The stock or index is moving up, making new highs or higher highs
- Downtrend: The stock or index is moving downwards making lower lows
- Sideways Consolidation: Neither making significant new highs or new lows
There are also time frames to consider in evaluating a trend; for this, we will refer to Charles Dow’s classification in Dow Theory.
Types of Stock Trend Time-Frames:
- Short Term: Days to weeks
- Medium Term: Weeks to months
- Long Term: Months to years
By combining the above terms, you could be specific about the market trend. For example, you could say the market is in a short-term up-trend, but a long-term down-trend. But isn’t that contradictory, the market being in both an uptrend and a downtrend at the same time?
Not really, it makes perfect sense.
The Following Examples are an excerpt from the Liberated Stock Trader Academy Book and Training Course. Chapter 7, Section 2.
Drawing trend lines is one of the essential skills of technical analysts; trend lines represent important areas of support and resistance. Once you have this skill, charts come to life and start to signal their message to you.
How to Draw Trend Lines: Uptrends
Example 1. Drawing UpTrends
- To evaluate an upward trend draw a line joining the highest highs
- For the floor of the uptrend, draw a line connecting the lowest lows. The price here bounces three times off the bottom line but then proceeds higher.
- A trend line is drawn to show that price has moved strongly past the previous high this is a BUY Signal at $35.50.
- Finally, the price is exhausted and falls through the bottom resistance line at $51. This break of the upward support line is a sell signal.
Quick Tip: The more bounces off a trend line the stronger the trend.
Buying and selling based on the trend lines shown here would have bagged you a 49% win. Alas, life is never that easy, and showing this in retrospect does mean we have the benefit of hindsight.
How to Draw Support & Resistance Trend Lines
You must practice drawing trend line as much as possible, after a while you will get used to it, and it will become second nature.
Here is another example of how to draw trend lines. This is a chart of Ticker: AAPL Apple Inc. it shows how to draw trend lines in a downward price move and an upward price move.
Practice drawing trend lines Ticker: AAPL Apple Inc
Notice that the trend line above the price is called resistance, and the trend line below price is called support. When price breaks up through resistance, it moves higher; this could potentially be a buy signal. When the price breaks down through the support trend line, it moves lower; this could possibly be a sell signal.
Quick Tip: The longer the trend line is in place or acts as support or resistance, the stronger the trend and the bigger the move when the trend line is broken.
Look again at the chart of Apple Inc. See how Apple was in a sideways consolidation from 2001 through to 2004. When it eventually broke out of that channel upwards through resistance, the stock took off, making over 1600% gain.
Chapter 7 of the PRO Training delves deeper into the technical analysis to enable you to make Buy and Sell decisions using trend lines, spot the most important patterns, trends and discusses the importance of Price Gaps, Triangles, and Wedges.
How To Draw Trendlines Video
Please excuse the sound quality – it was a live broadcast.
Drawing Trend Lines to Recognise Stock Chart Patterns
If you cannot draw a Trend-line you should not invest in the stock market!
In this example, we will examine how to look at price movement and use it to evaluate the stock.
Price is known as the most critical indicator, and so it should be when it boils down to it the most important thing is the price.
Here we can see a chart of Broadcom (BRCM), one of the darlings of the tech bubble in 2000.
Where will you draw the trend lines?
Take a moment to think about where you would draw the trend lines before you scroll down to the chart where I have drawn them.
Broadcom Chart with Support & Resistance and a Double Bottom Pattern Trendlines
A chart can really come alive when we add trend lines. The graphic below shows BRCM, with trend lines, superimposed.
- Starting from left to right, we see from mid-April to July, the stock begins to move in a sideways pattern, known as “Channeling.”
- The two red lines show the “trading range”; this is the range between which the stock price fluctuates.
- The upper line is known as the Ceiling or the “Line Of Resistance,” and the lower the Floor or “Support.” Both lines show where the number of sellers equals that of buyers.
- When the stock price falls through the support line, it means the trend has changed, and the new market impetus has affected the stock. If you owned this stock in April and enjoyed the corresponding price rise, this break would be a reliable “Sell Signal” to the trained eye.
- The stock consequently dropped in 2 days but also had the good courtesy to rise again over the following month to give anyone slow on the uptake another chance to Sell. It broke through the previous support line but was not strong enough to make it to the upper ceiling of the channel. If you had not got out this time, you would have suffered a punishing 50% loss. Enough to make a grown man weep!
- The next significant point to note is in mid-October when the stock bounces at about $13, clearly oversold, and proceeds to make a very nice looking “Double Bottom” or “W” bottom.
- Chartists the world over recognize the double bottom, and those that like to buy on Bottoms would have done. This clearly happened as the stock moved up 38% in 3 weeks.
Drawing Trend-lines to Make Buy and Sell Decisions
So we have seen the Sideways Channel and the W bottom. But how do we know when a stock is going to take off?
The truth is we never really know.
All we can do is make judgments based on what we see. Do not forget we are only buying Stocks of companies that have
- Excellent Earnings per Share
- The sharp acceleration in the growth of Earning per Share
- Excellent Revenue growth
So we are, in essence, giving ourselves a great head start and reducing our overall risk.
4 Step Guide to Using Trend Lines for Buy & Sell Decisions
4 Steps to Draw the Trend Lines on the Chart
- To evaluate an upward trend draw a line joining the highest highs
- For the floor of the uptrend, draw a line connecting the lowest lows. The price here bounces three times of the bottom trendline but then proceeds higher. The more bounces off a trend line, the stronger the trend.
- A trend line is drawn to show that price has moved strongly past the previous high, this is a BUY Signal at $35.50.
- Finally, the price is exhausted and falls through the bottom resistance line at $53.
Buying and selling based on the trend lines, here, would have netted you a tasty 49%.
Alas, life is never that easy, and showing this in retrospect does mean we have the benefit of hindsight. This is why the finest minds of Wall St. have a whole host of other technical indicators that accompany price to enable you to assess trend quality. These will be discussed in other chapters.
There are still other vital lessons to learn.
Other Chapters of the Liberated Stock Trader Book are listed below
This chapter sets the stage for the two key areas of stock market technical analysis and the fundamental analysis of companies including macro and micro economics
This chapter looks at what REALLY makes the markets move, what causes boom and bust cycles and how to spot them.
What are stock market cycles and the cycles of business and economies. Important information that you need to appreciate as part of your core analysis.
Next we move into fundamental analysis and the financial fitness of a company. All the major indicators and measures are covered.
Stock screening means using criteria to short list the kind of stock that you want to purchase. A vital part of any stock market training
Once you know the business climate, the state of the economy and you have shortlisted the stocks you want to buy. The next thing to do is the technical analysis. Even if the company looks great on paper, if the stock price is plummeting you do not want to buy it until it has bottomed out. This is called catching a falling knife. This is what chart patterns and technical analysis helps with.
Here we get into the art of drawing on charts to help you visualize the Supply and Demand on the stock, the direction of the trend and estimate how long the trend will last. Vital for you to establish buy and sell signals.
Which indicators should you use, there are literally hundreds of stock chart indicators. Each have a specific use case and application, which should you use?
Volume is a vital indicator along with price. Both of these you need to understand in granular detail, you will learn everything you need to know.
Moving to advanced technical analysis we cover indicators such as parabolic SAR and point & figure charts.
How are the market participants feeling? Positive, Negative or indifferent. Consider that 90% of people fail to beat the average market returns, sentiment indicators can be a great contrary indicator. Lean how to use them to your advantage.
Understanding how you want to invest, how much time you have and your time horizon. These questions all help you to understand what type of investor you want to be, this then enables you to select the right strategy for you. Then we move on to building your stock investing system, a critical element to your plan.