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Chapter 3 Stock Market Trend Lines

Trend line

The popular saying in the market on Trend-line is “The trend is your friend, until the end when it bends.” A Trend line is a straight line that connects two or more price points and then extends into the future to act as a line of support or resistance.

An uptrend line has a positive slope and is formed by connecting 2 or more swing lows (blue arrow - below). A downtrend line, on the other hand, has a negative slope and is formed by connecting 2 or more swing highs (red arrow - below).

Using Trend lines

Trend lines are useful because:

  • They provide support or resistance level

  • They act as an early warning signal of trend change

Uptrend

“Uptrend” is defined as a series of higher highs and higher lows. In this process, the share prices move in the upward direction touching new highs. For example, in the following diagram, note that H4 > H3 > H2 > H1 and L4 > L3 > L2 > L1. Here, H4, H3, H2 are known as swing highs and L4, L3, L2 are known as swing lows.

Downtrend

“Downtrend” is defined as a series of lower highs and lower lows. The share price moves in the downward direction making new lows in the process. Hence, the best indication of a downtrend is the price making a lower top and lower bottom.

Flat or Sideways trend

“Flat” or “Sideways” trend is a situation where prices move in a range, neither going upward nor downward. They move in a horizontal direction for a long period of time.

Catching the trend

Markets trade in a range or stay flat most of the time. However, when the price breaks out (trades above the range) or breaks down (trades below the range) - the price extends by at least the same amount as that of the range.

Key Takeaways

  • Trend lines are amongst the easiest technical tool to understand, but considerable practice is required before we can successfully interpret trend lines.
  • Markets tend to move in three trends - uptrend, downtrend and sideways trend (consolidation).
  • Trend line violations signal either a temporary interruption or a reversal in the prevailing trend. It is necessary to refer to other pieces of technical evidence to determine what is being signaled.
  • A good Trend line reflects the underlying trend and represents an important support and resistance zone.
  • The relevance of Trend lines is a function of their length, the number of times they touch and the steepness of ascent or decent.
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