Trends and Trend Lines Concept: Stock Market
Trend lines are effective tools for locating trends and determining if a trend is still in effect. A broken trend line does not necessarily lead to a reversal; sometimes the price simply drifts sideways after a trend has terminated. Steep trend lines tend to break easily, while a gently sloping trend line may show more resilience.
Trend
when prices are moving in a clear, consistent direction. A persistent directional price movement is called a ‘‘trend.’’
Uptrends
An uptrend consists of price movement that forms a series of higher lows (HL) and higher highs (HH). In the case of an uptrend, the trend line is drawn upward beneath a series of ascending lows. When the price pulls back to the trend line in an uptrend, it is considered a buying opportunity. In this situation, the trend line is treated as a support level. If the price breaks through the trend line, then the trade is exited, as support is considered to be broken.
Downtrends
A downtrend consists of price movement that forms a series of lower highs (LH) and lower lows (LL). In the case of a downtrend, a trend line can be drawn downward above a series of descending highs. When the price rallies to the trend line in a downtrend, it is considered a selling opportunity. In this situation, the trend line is treated like a resistance level. If the price breaks through the bearish trend line, then resistance is considered to be broken, and any short trades that were entered are closed.
In either case, a trend line must connect a minimum of two points. A trend line that connects two points is called a ‘‘tentative’’ trend line; a trend line that connects at least three points is known as a ‘‘valid’’ trend line.
The more times the trend line has been tested (meaning that the price has come into contact with the line) without being breached, the stronger it is considered to be. Trend lines of greater duration are considered superior to those of a shorter duration.
Breaking the Trend Line
Sometimes the price will trade through a trend line for a short time, only to return to its original position. Such minor violations aren’t considered true trend breaks. There is no firm written rule as to what constitutes a broken trend line, but many traders want to see the price close beneath a bullish trend line (or above a bearish trend line) before they consider the trend line to be broken.
Consolidation
A consolidation is a period of rest that occurs after a trading vehicle has made a significant move. A chartist might say that stock XYZ is ‘‘consolidating its gains’’ after a strong move higher, or ‘‘consolidating its losses’’ after a sharp decline. While a break of a trend line doesn’t necessarily indicate that a sharp reversal is about to occur, it does call the validity of the trend into question.
Angle of the Trend
Another consideration is the degree or angle of the trend line. Lines that are sharply inclined tend to be easier to break, as the trend could be moving at an unsustainable pace. Chartists sometimes refer to price action of this nature as ‘‘parabolic.’’
Multiple Trend Lines
Many times, a chart that has more than one potential trend line. In such cases, it’s acceptable to draw more than one trend line on the chart. Since multiple trend lines can coexist on a chart, there is no ‘‘correct’’ trend line. However, it’s very likely that there is a dominant trend line. A major trend line has more activity and/or a greater length of time associated with it than a minor trend line.
Channel Lines
An uptrend as a series of higher highs and higher lows, with a trend line drawn beneath the series of higher lows. On some occasions, a parallel line can be drawn above the series of higher highs as well. These parallel lines are referred to as a bullish channel. In a bullish channel, the lower line is the trend line, and the higher line is the channel line.
Similarly, a downtrend is defined as a series of lower highs and lower lows, with a trend line drawn above a series of lower highs. When a parallel trend line, known as a channel line, can be drawn beneath the series of lower lows, the result is referred to as a bear channel.
Using Channel Lines
A pullback to a bullish trend line drawn along a series of higher lows can be used to initiate a long position. An aggressive trader could then exit the position with a profit if and when the price reaches the upper boundary of the channel. A more conservative trader could use the center of the channel as a target. If the bullish trend line breaks, the trader would exit the position at a loss.
Similarly, a rally to a bearish trend line drawn along a series of lower highs can be used to initiate a short position. The trader could then exit the position if and when the price reaches the lower boundary of the channel. A more conservative trader could use the center of the channel as a target. If the price breaks upward through the bearish trend line, the trader would cover the short position at a loss.
In both cases, another tactic would be to exit half of the position at the center of the channel and trail a protective stop on the remainder of the position.
Support Becomes Resistance
A trend line as horizontal support can become horizontal resistance, diagonal support can become diagonal resistance.
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