by Martin Pring
The trend of prices is the feature that is most sought after in technical analysis, yet surprisingly simple constructs can get you right with the market. Here, veteran trader and analyst Martin Pring takes you through the basics of creating and interpreting trendlines.
Trendlines are a simple but highly effective tool. In technical analysis, we assume prices move in trends, and that once begun, a trend continues. Therefore, you, as a technician, must be concerned with identifying a price reversal at an early stage and riding it until the evidence proves the trend has once again turned. Trendlines represent one of these items of evidence.
FIGURE 1: DOWN TRENDLINE
A down trendline is constructed by joining a series of declining peaks. A buy signal is triggered when the down trendline is violated. It is normal to begin with the first or highest peak, then connecting the line to the second as in line 1. This is known as a primary trendline. Never draw a line that does not touch any of the peaks such as the trendline drawn in line 3, because it is merely a line drawn in space with no forecasting significance whatsoever.
On the other hand, it is permissible to ignore the highest peak and connect some of the others. An example can be seen in line 2. This is known as a secondary trendline. Secondary trendlines are perfectly valid because they offer a good rendition of the underlying trend. A trendline of this nature is far better in this instance than the dashed line drawn from the peak, which was too steep to be sustained.
Trendlines are not perfect tools, but then, what technical indicators are? In my experience, however, they can be highly effective. If I had to be cast off on a deserted island with only two or three technical indicators, I would not hesitate to take trendlines along.
Martin J. Pring, a leader in the US investment community, entered the financial markets in 1969, founding the International Institute for Economic Research in 1981. Described by Barron's as a "technician's technician," Pring is the author of several books, including the classic Technical Analysis Explained, and Introduction To Technical Analysis, the first technical analysis multimedia CD-ROM. He pioneered the use of videos as an education tool for technical analysis in 1987, and was the first to introduce educational interactive CDs in this field. He may be reached via E-mail at info@Pring.com/.
Excerpted from an article originally published in the March 2000 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2000, Technical Analysis, Inc.
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