V.9:2 (77-80): Trendlines by Melanie F. Bowman and Thom Hartle

Trendlines by Melanie F. Bowman and Thom Hartle

Trendlines are those lines drawn on charts to assist the technician in analyzing a market. A trendline drawn below rising prices is known as a demand, or oversold, line, while a trendline drawn above declining prices is known as a supply, or overbought, line. The direction of the trend is indicated by the ascending trendline or the declining trendline. A penetration of the trendline by price is clear evidence of a change in the trend. In addition, trendlines also give an analyst the added benefits of gauging whether a trend is accelerating or on the verge of dying out, setting price objectives for trend reversals and choosing target prices at which to increase the size of a short or long position.

In the classic uptrend, highs and lows both get higher. The trendline is drawn through at least two, and preferably three, ascending lows. The first step is to identify the low prices on a bar chart that are significant in regard to the establishment of the up trendline. Since an up trendline is another name for a demand line, then looking for any evidence of demand is the first step in determining the placement of the trendline. Typically, demand patterns will encompass two to five trading days. The simplest pattern .. is basically a three-day head-and-shoulders bottom, as shown in Figure 1. The low for Day 1 is surpassed on Day 2, while on Day 3 the low for that day is at the approximate price level established on Day 1. Day 1 is the left shoulder, while Day 2 represents the head and Day 3 is the right shoulder. The low on Day 3 — at the same level as Day 1 — indicates that buyers are increasing their level of commitment or willingness to buy aggressively. This is a positive sign of demand.

Another demand pattern is a two-day double bottom (Figure 2). Here, the buyers have established long positions two days consecutively. During an uptrend, a demand line should be drawn connecting these patterns (Figure 3, points a and b). Projecting this line forward will establish price levels that the technical analyst will be able to use to anticipate demand or support for the market. Similarly, in a downtrend, the lows continually move lower, as do the highs. The down trendline represents a supply line.