Trendlines with Candlestick Analysis

Using Trendlines with Candlestick Analysis

One of the most commonly used indicators is the trend line. Trend Lines are visually apparent levels where support or resistance has been occurring. Tech­nical analysis is built upon the premise of identifying trends. They are one of the most important tools for both identifying a trend and confirming the exist­ence of that trend. They are the simplest indicators to place on a chart. When analyzing any chart, the eye can usually distinguish an area where a line could be drawn across the bottoms or the tops.

The basis of a trendline is that it is formed when connecting at least two points. The more points that fall upon that line, whether actually drawn or visually evaluated, the greater the confirmation that the trend is being affected by that trendline. Many of the principles that are applied to other support and resistance indicators can also be applied to trendlines.

Many technical analysts require that a trend line be confirmed by at least three points touching that line. A rising trend line is identified with successively higher low-price points. The rising slope is now considered a support level. The Bulls are in control, providing demand every time prices come back to test the trendline. As long as the prices remain above the up trending trendline, the uptrend is considered intact.

As illustrated in Fig. 7, the March crude oil chart, a Bearish Engulfing signal appeared when the stochastics still indicated more upside potential. The trendline drawn from the top of the October high through the recent top at the January high can now be viewed as an important resistance. The candlestick “sell” sig­nal provides an ‘alert’ for selling to appear at this level when the stochastics indicated that there was still more upside to this trend.

Fig. 7, the March crude oil

Had this trendline not been acknowledged prior to the Bearish Engulfing signal appearing, going bade to analyze the chart after the Bearish Engulfing signal appeared provides an additional technical parameter for evaluating what the price of crude oil may do from this point. This is a case of using the trend-line to add credence to a candlestick signal.

This falling trendline acts as the resistance level. The Bears are in control, stepping up their selling every time the price comes up to the resistance area. As long as prices remain below the declining trendline, the downtrend is con­sidered to be in effect.

The use of computers has refined the use of trendlines in recent years. The accuracy of drawing trendlines on a computer screen is much greater than using a pencil and a ruler on a printed chart. The width of the pencil lead versus a slight change of angle of a manually drawn line could dramatically alter a trend lines relevance. Today’s computer generated charts can establish a trend line using the exact tops and bottoms of price moves. This would become very important for those investors that were anticipating a breakout of a trendline support or resistance level.

The strength of a trend becomes a function of how many times prices bounce back up above the trendline. As mentioned, a trendline can start by drawing a line between two points and extending that line into the future. If that trend is to continue, then future prices should support or resist at that line. That becomes the primary basis for trend analysis. The candlestick signals dra­matically increase the evaluation potential at the support or resistance line. Where most investors are “anticipating” a result at that trendline, the candle­stick analyst can get an immediately clear picture of what investor sentiment is doing at the trendline. This not only provides valuable investment information, it provides that information much earlier than what other investors are able to glean from the trading at that level.

The disadvantage of using trendline analysis on its own is the different interpretations of which trendline is most relevant. Establishing that a trendline can be formed by two, three, and more points being used to develop a trendline, there is the possibility that different combinations of those points can create a short-term trend, medium-term trend, or long-term trend. The question now becomes which trendline is providing the correct analysis for support and resis­tance. Utilizing the candlestick signals assists in recognizing which trend-line is the prominent trendline.

Developing a trading strategy utilizing the candlestick signals at the trend lines becomes much more decisive. If a trendline is anticipated to be acting as a support, and that is being confirmed by a candlestick buy signal, purchasing the trading entity at that level produces a couple quick distinctions. The candle­stick signal allows the investor to enter a trade at a highly opportune time. It also provides a logical stop loss strategy. If the buy signal occurs on a trendline, implying that the uptrend is going to continue from that point, then prices immediately coming back down through the trendline, the support level, alerts the investor to close out the position immediately. This should not be a difficult concept. If the indicators that had been working previously appear to work once again but immediately reverse and fail, then a major support level has been breached, immediately indicating the buying that showed support is not present where it is supposed to be seen.

Fig. 8, The Hansen Natural Corp. chart illustrates an ascending trendline. After two or three times of coming back to a level that appears to be in a straight line, the eye can start to visually detect what would appear to be a trendline forming.

Fig. 8, The Hansen Natural Corp

Drawing a line from those points now becomes a potential target for each pullback that occurs. Being that the visual analysis is easy for most investors to perceive, a trendline becomes an important technical factor. As viewed in the Hansen Natural chart, any future pullbacks to the trendline become an obvious spot to watch for candlestick signals. Having the mental image of where sup­port might occur and being able to visually recognize candlestick buy signals allows the candlestick analyst to make better decisions for entering a trade.

Trendlines can be developed by using points in the past that all appear to be lining up. If a number of points line up from two different time frames or more, the chart might have different trendlines that could be relevant. Which one of those trendlines should be heeded? The candlestick signals make the answer very easy. If there is more than one trendline to be considered, then the candlestick signals will help identify which trendline has importance. This is just a simple function of seeing where a candlestick “buy’ signal has formed. Fig, 9, The General Cable Corp. chart illustrates a couple of trendlines that have been created from previous bottoms. Which trendline will work effec­tively for the period we are looking at right now? The signals will tell you which trendline should be currently considered.

As seen in the General Cable Corp. chart, during an expanded time frame, there are two trendlines that appear to act as support levels.

Fig, 9, The General Cable Corp. long-term chart

Once the long-term chart, Fig.10, has established important trendlines, the analysis of what to do currently is better visualized by shortening the timeframe of the chart. This better illustrates what is currently occurring in the price pat­tern.

Fig, 10, The General Cable Corp. Short-term chart

Making the chart bigger for better visualization, it can be clearly seen which trendline is affecting the current price. In this case, the Inverted Hammer is being confirmed at the upper trendline.

This may seem very elementary, but it is what is occurring at trendline levels that are being observed by many investors. The candlestick signals con­firm immediately what is happening at an observed level.

Trendlines also become important factors when acting as resistance levels. Fig. 11, The Magnum Hunter Resources chart provides a simple illustration of what occurs every time prices approached a specific trendline. It became apparent that every time a peek was reached in June, July, and August, candle­stick sell signals appeared. Mid-September revealed candlestick formations that did not show weakness at the trendline. This becomes important information for the candlestick investor. The fact that a bullish candle formation breaches what had obviously been a resistance trendline reveals that there is new inves­tor sentiment.

A bullish breakthrough as revealed by the candle formations demonstrates that the trendline resistance has now become a non-factor. If this position was purchased, based on bullish candle signals forming at important moving aver­ages, the decision process should be to take profits at the obvious resistance level. That decision now becomes different once the resistance level is broken. Simply stated, the lack of a candlestick ‘sell’ signal where a ‘sell’ signal is ex­pected provides a new evaluation.

Fig. 11 Magnum Hunter Resources

If trendlines are creating obvious formations, such as pennant formations or ascending triangles, etc., then a breakout from those patterns can be better analyzed when viewing the candlestick formations. This is not a complex pro­cedure. This is using the simple visual analysis of investor sentiment at previ­ous levels that would indicate buying and selling.

Fig. 12 The DJ Orthopedics Inc. chart illustrates a Triangle formation that is breached to the upside. When viewing the longer term chart, it becomes rela­tively clear- that there is a triangle pattern forming. If those trendlines are brought forward into a shorter term chart, the analysis is easy to formulate once one of those trendlines is breached.

Fig. 12 DJ Orthopedics Inc. long term chart

In the short-term chart Fig. 13 (following page), it becomes apparent with the large bullish candle that the trendline is now no longer a resistance level. The fact that the Bulls pushed through that trendline with great force reveals important information. That information now creates a new evaluation of what the trend might be for the future of this stock. Although a sell signal was cre­ated the day after the break through, with a Bearish Harami, a pullback stopped at what had been the resistance trendline, with it now becoming a support level. The fact that the trading was now above descending trendline should bring a different evaluation into this stock. The candlestick signals are still the most relevant factors for trading decisions, but the overall trend analysis will have changed.

Fig. 13 DJ Orthopedics Inc. Short term chart

Keep in mind, when everybody is watching to see what will happen at impor­tant technical levels, the candlestick analyst has the advantage of immediately seeing what the investor sentiment is doing at those levels.

Fig.14, The Phelps Dodge Corp. chart reveals a bullish candle that broke out through what had been a resistance trendline. The bullish candle of the previ­ous day, followed by a bullish candle with a gap up becomes very revealing. What is the future of the price of this stock? Who knows! But the evaluation of this price move now becomes different, knowing that a trend line resistance congestion area has now been broken.

Fig.14, The Phelps Dodge Corp.

Trendlines can be used to analyze what candlestick signals “might” be occur­ring in the near future. As seen in Fig. 5-15, the Wamaco Group Co. chart, the price move has become extended up to one of the obvious trend lines. The price closed remarkably close to that trendline on a big bullish candle day. This alerts the candlestick investor to a couple of possibilities. Seeing strength, the following day should reveal that the next trendline might be the target. A weaker open on the following day may reveal this trendline as the resistance level. A Bearish Harami would signify that the buying had stopped. This, occurring at that trendline, would be more confirmation to take profits.

Fig. 15 Wamaco Group Corp.

An ascending triangle chart, as seen in Fig. 16, the KCS Energy Inc. chart provides important information. The trendlines being drawn across the top and the bottom of the trading pattern should reveal the simple patterns in which that this stock characteristically trades. Once that trading pattern has been breached, a new evaluation can be made for the price movement. Having the advantage of knowing that the trend is now in a new stage of development, in this case a bullish move, the use of candlestick signals becomes more effec­tive. They can be used knowing that an uptrend is in progress. The potential of the trend should continue until a definite candlestick ‘sell’ signal appears. Or a pullback could occur, testing the recent resistance level. Having the knowledge of what could potentially happen after a breakout allows the use of candlestick signals to enhance the probabilities of being in the correct direction of the trade. This is nothing more than putting the probabilities more into the inves­tors favor.

Fig. 16, the KCS Energy Inc. chart Long Term

Fig. 17, the KCS Energy Inc. chart Short Term