How To Spot a Trend

HOW TO SPOT A TREND

In the course of a stock’s normal wavy movement across the chart, as few as three points, each marking the top or bottom of a wave, may suggest the presence of a trendline; more are usually needed to confirm it. In Figure 5, note that in the uptrend, the third point, C, becomes fixed at a higher level than the first point, A. With only three points observed so far, the trendline may be difficult to recognize until prices move away from Point C and in some cases actually cross Point B. In the downtrend, Point C is lower than Point A. "Sideways,” or horizontal trendlines may occur when Point C is even with Point A.

Please note that the uptrend line is drawn by connecting the lower points of a stock movement. A downtrend line must be drawn by connecting the higher points. This is an important distinction. The inexperienced chart reader invariably—and quite naturally—does the opposite, drawing uptrends from the upper limits and downtrends from the lower ones. This technique appears to work at times, but experience has shown it to be highly unreliable and of little use in precise forecasting, where it is desired to determine at what point a stock is likely to halt on its next swing. When a sideways trend forms, both upper and lower points often conform to parallel, straight horizontal lines, but it is safer to draw a sideways trendline along the low points, as one does for a hypothetical uptrend.

Figure 6 (page 31) shows how trendlines and channels would look on a daily basis vertical line chart. Flow trendlines actually develop are shown in the charts at the end of this chapter, all taken from actual market action. The heavy, solid lines are the trendlines. The broken lines, which were drawn parallel to the trendlines, help to outline channels. Briefly, channels are grooves or ducts through which prices move as they zigzag along a trendline. Once a trendline has been clearly established, a channel can usually be determined. Needless to say, channels seldom occur as neatly defined as in the selected charts shown in Figure 6, but when found, they are useful in suggesting at what price to buy or sell, if the decision to buy or sell has been made.

It is perhaps obvious that the longer a stock has been moving along a given trend, or within a given channel or groove, the stronger that trend is likely to be. For this reason, trendlines on longer range charts such as weekly or monthly high-low-and-close charts are usually more reliable than trendlines that form on daily high-low-and-close charts. Trendlines that form in just a few weeks cannot be expected to hold in the majority of instances. But, even when stocks break away from an established line, and signal a true shift in direction, they have a tendency to return to it. This magnetic attraction of the old trend, this "pull-back effect” common to trendlines, will be observed on the completion of many of the formations covered in later chapters. An awareness of this movement can help the timing of purchases and sales.