Trendlines – Background
Trendlines offer a level of support for a stock’s share price as it progresses. Shorter-term Trendlines tend to have steeper angles than longer-term Trendlines. The longer a Trendline can go without having too many breaks below the Trendline, the stronger support the Trendline should provide during the stock’s correction.
For a Trendline to be a Supporting Trendline, the stocks share price has to be above the Trendline. Once the share price falls below the Trendline, the Supporting Trendline usually turns into a Resistance Trendline.
When a stock’s share price is increasing and breaks through a Resistance Trendline on heavier than normal buying volume, that indicates that the Trendline’s resistance may have been broken. Conversely, a decreasing share price that breaks through a Supporting Trendline on heavier than normal selling volume indicates that the Trendline’s support may have been broken.
I usually like to wait a few candlestick periods to see if the stock’s share price can successfully close and stay above a Trendline before purchasing shares. Over those few candlestick periods, I watch to see how it reacts around its new Supporting Trendline – that action can sometimes give you clues if the Trendline is going to offer support or if it is a bull trap.
If a stock’s share price is rising and approaches a Trendline above it (resistance), the share price will most likely need to see increased buying activity (increased volume) as it tries to break through the resistance area. If there is not an increase in buying pressure when a stock approaches a resistance area, then chances are good that the stock will enter into another correction period rather than continuing with its uptrend.
Small violations of a Trendline could indicate that the initial Trendline was drawn too tightly and should be adjusted to include the new data. Or the old Trendline can be left alone and a new Trendline can be drawn. It is okay to have multiple Trendlines on a chart. However, just because a stock pokes through a Trendline does not necessarily mean the Trendline has to be redrawn.
What can happen when a stock crosses below a supporting Trendline? Well, the share price can (a) go up, (b) go down or (c) move sideways. While nothing is for certain, the break of the Supporting Trendline at least provides a “likely indication” of where the share price is heading, which is (b) go down.
Breaks below a supporting trendline on heavy selling volume indicates that supply is outpacing demand for the stock and lower share prices are very probable. A stock that breaks its supporting trendline on heavy selling volume should be sold on any pushback towards the trendline as soon as possible to try and retain any gains.
Using Trendlines when the price action is neat and well-defined is pretty simple even for the beginning investor. However, when prices don’t bounce precisely off Trendlines and the share price behavior is ambiguous with respect to support and resistance levels, Trendline analysis can become far more challenging. That is when it is best to confirm the Trendline analysis with another types of technical analysis.
