Drawing trendlines

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Trendlines seem pretty straightforward, but drawing a trendline can be tricky. Based on how you think a stock is performing, you draw a line of support (in a bullish case) or a line of resistance (in a bearish case).

You can construct a trendline with nothing more than a printed out chart, a ruler, and a pencil. If you can't find a ruler, just close this book and use the spine. Anything that allows you to draw a straight line between two points will do. To draw a trendline, simply draw a line that connects two or more low price points (for an upward trending line) or two or more high price points (for a downward trending line). Figure 11-1 shows a prime example of a trendline.

jflNG./ Don't let the ease of trendline construction fool you into thinking that trendlines are simple or cut-and-dried. In fact, it's difficult to refer to a trendline on a chart as a technical indicator because the drawing of the line is such a subjective task. Much like the market experts debating on TV, it's very likely that two traders can come up with completely different lines when asked to draw what they consider the most significant trendline on a chart. If a trader happens to be biased against a certain stock for some reason, she may be more inclined to look at a chart and find a downtrend.

Despite all the subjectivity involved with drawling trendlines, some very successful traders rely heavily on them for their buy and sell decisions. When I began my career as a runner in the cattle trading pits 15 years ago, a very successful trader I knew based decisions on nothing more than daily charts and trendlines that he'd drawn during his train ride every morning. I've heard that he's still using the same method today.

Considering trendline direction

Although different trendlines drawn on the same chart may differ a bit, you'll usually find that at least the direction of the trendlines are the same. Trendlines can trend up, down, or not at all. For simplicity's sake, Figure 11-1 has an obvious up (bullish) trend. (I say it's obvious, but I wonder how many of my colleagues will insist I'm wrong!) After you determine that a trend is bullish, you may consider it with a bullish candlestick pattern and look to buy. On the other hand, if you witness a bearish candlestick pattern, you may be inclined to ignore it, or at least to take caution before implementing a sell signal.

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A chart showing a trendline with a positive trend.

Taking trendline direction into consideration helps you determine the status of the market. Understanding the market helps you use the most appropriate candlestick pattern — one that makes your trading decisions more effective and profitable. Trendlines can be subjective, but there's no easier or quicker way to define a trend.

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