CLASSIC TECHNIQUES
In Vectors Veritas
The Truth About Trendlines
by Thomas Bulkowski
Many of the rumors about trendlines are true. Find out what the facts are here.
Is it true that the longer a trendline is, the more significant it becomes? The answer is yes, but this in turn raises other questions. How long should the trendline be to qualify? What is meant by significant? While researching my book Trading Classic Chart Patterns I found lots of platitudes, but little substance. No one seemed to know how well trendlines behaved, or at any rate no one was telling. I decided to find out.
A BRIEF REVIEW
In case you are unfamiliar with trendlines, take a look at Figure 1. Here, downsloping trendlines along daily prices connect the minor highs. This way I can see when the trend changes from down to up (as it did in October 2001, when prices briefly closed above the trendline).
Similarly, I draw upsloping trendlines connecting the minor lows. Again, I'm looking for a trend change warning, and when prices close below the trendline, that's when I get worried.
I avoid drawing the trendline through prices, as in the internal trendline shown in Figure 2. To draw internal trendlines, ignore the one-day price spikes (called tails) and base your trendline on what the majority of traders are doing. This way, you move with the crowd and ignore the independents. Since I use trendlines to help identify price-trend changes, any piercing of the trendline becomes a warning signal. On the other hand, internal trendlines by definition pierce prices often, rendering them almost useless as a trend-change indicator.
FIGURE 1: TWO TRENDLINES. One trendline slopes downward, connecting the minor highs, and the other slopes upward along the minor lows. When prices pierce the trendline, it is a warning, but no guarantee, of a trend change.
...Continued in the October 2002 issue of Technical Analysis of STOCKS
& COMMODITIES
Excerpted from an article originally published in the October 2002 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2002, Technical Analysis, Inc.