This column is devoted to technical analysis, which studies the supply and demand for securities
based on price activity and trading volume. Charts and indicators are used to uncover patterns that
Trendline
Basics
Sometimes it feels like computers
can make things more complicated
than they really need to be. One case
in point is technical analysis. With
affordable computers available to the
masses, it seems like the battle be-
tween software makers is to see who
can pack the most features into their
programs. However, sometimes the
most simple of analysis techniques
can be just as useful as the most
complex indicators.
Trendlines are one of hallmarks of
technical analysis. This makes sense,
given that technical analysis is built
on the premise that prices trend.
Well-known technician John Murphy
wrote this about trendlines in his
book The Visual Investor: The supply even as the price rises. In-
simple trendline is possibly the most
useful tool in the study of market
trends. And youll be happy to know
that theyre extremely easy to draw.
In this installment of Technically
Speaking, we discuss the basics of
trendlines and how you can use them
in your investing.
A trendline is a straight line that
connects two or more price points.
Extending this line into the future,
it also acts as a line of support or
Figure 1. Up Trendline
30
may point to future price movements.
resistance. There are two types of upward price movement.
trendlinesthe up trend and the
down trend. Down Trendline
A down trendline has a negative or
Up Trendline downward slope that is formed by
An up trendline has a positive connecting two or more high points.
slope, meaning it rises as you move The second high must be lower than
from left to right on the chart. An the first in order for the line to have
oft-used definition of an up trend a negative slope (lower lows and
is higher highs and higher lows. lower highs). Figure 2 shows a down
Typically, up trendlines are formed by trend.
connecting two or more low points Extending the line forward pro-
on a chart. The key is that the second vides an estimate of future resistance
low must be higher then the first levels. During down trends, supply
in order for the line to have a posi- is increasing relative to demand even
tive slope. Figure 1 illustrates an up as prices fall. A declining price with
trend. increasing supply is a bearish sig-
Extending the up trendline into the nal; the down trend remains intact
future provides a good indication of as long as prices remain below the
future support levels. As long as the down trendline.
trend is up, demand is outstripping A break occurs in the down
trendline when prices move above
creasing demand in the face of rising it, indicating that supply begins
prices is a bullish sign and as long as to wane relative to demand. Such
prices remain above the trendline, the breaks above the down trendline may
up trend is considered intact. indicate that a change in trend is im-
Eventually, there will be a break minent. However, it is a good idea to
below the up trendline. This occurs wait until the price establishes higher
when supply begins to outweigh de- bottoms before drawing a new up
mand. Breaks below the up trendline trendline.
indicate a change in trend could be
coming. Once the up trendline is Validation
broken, chances are it may become a As we said, it takes two or more
level of resistance that stifles further points to draw a trendlineup trend
or down trend. How-
ever, when looking
to draw trendlines,
the temptation is to
merely draw them
through extreme
high and low points.
It is better to draw
a trendline through
points where the
price has momen-
tarily pulled back
and reversed direc-
tion. The more times
prices touch the
trendline, the more
valid the line
becomes as a level of
support or resistance.
Without two points,
Computerized Investing
you cannot draw Figure 2. Down Trendline
a trendline. There-
fore, it is not always
possible to create a
trendline.

Spacing
The spacing of the
lows used to form
an up trendline and
the highs used to
form a down trend-
line should not be
too far apart, or too
close together. The
proper distance
between points will
largely depend on the
timeframe used with
the chart, as with
Figure 3. Internal Trendline
all price movement.
Ideally, trendlines are
made up of relatively
evenly spaced lows
or highs.

Steepness
The steeper the
trendline, the less
valid the support
or resistance level
it represents. Steep
trendlines are caused
by sharp advances or
declines over a short
time period. Prices
that are moving
upward or down-
ward rapidly cannot
be sustained in a trend; eventually points sparingly, as the more points other lows over this period.
prices will move below or above the you ignore to fit the trendline, the
trendline. less meaning the line carries. Conclusion
The long-term trendline for Potash Trendlines are a simple way to
Internal Trendlines Corp. (POT) in Figure 3 extends illustrate the trend of the market
There may be times when you are upward from August of 2007 and or an individual security. However,
drawing a trendline that the highs passes through the lows in January like any technical analysis tool, they
and lows will not match up exactly, 2008 and March 2008. These lows can generate false signals if they
perhaps because the angle of the were formed with selling climaxes are not used properly. Furthermore,
trendline is too steep or the points and represent extreme price move- trendlines should not be your sole
are too close together. In these cases, ments that protrude beneath the decision-making tool. Using other
you may be able to draw internal trend line. By drawing the trendline technical indicators can help you
trendlines that ignore one or two through these lows, the upward confirm whether a change in trend is
points. However, you should ignore trendline matches better with the taking place.

Third Quarter 2009 31