4. Trend Lines & Channel Lines
No overview of chart reading would be complete without covering trend lines. The thing of it is, we don’t really like to use them. What? A trend follower who doesn’t include trend lines on his charts? Blasphemy!! We’ll state our case later, but first let’s tell you what trend lines are and how chartists use them.
Trend lines are straight lines that chartists draw on their charts to help them define a trend. The lines are drawn by connecting certain price points on the chart (technically, at least 3 points).
> In the case of an uptrend, the line is usually drawn through the major lows of the price bars. As long as the trend line remains intact (prices don’t go below it), the uptrend is intact. Here’s an example on a Verizon chart:
> In the case of a downtrend, chart folks will usually “connect the dots” through the major highs of the price bars. As long as prices don’t move above the trend line, the downtrend is intact. Check out this chart of Canadian Solar:
Drawing trend lines can be pretty arbitrary among chartists. Some like to draw them through the closes on the price bars. Some like to draw them through lows that have the greatest volume on the price bars. Some like to draw them above and below the price action, creating “channel lines” (short term traders like to use channel lines to place quick trades on bounces off those lines). Here’s an example of channel lines on the daily chart (short term) of Fastenal:
Regardless of how it is drawn, a trend line’s purpose is to define the trend on the chart. For the most part, chartists believe a trend is broken, or at least in doubt, when its trend line is broken by prices moving through it, or violating it (that sounds bad, doesn’t it?). Trend followers using trend lines on their charts would watch for such violations to alert them that a trend change is possible.
Here’s our problem with trend lines: they’re straight! As we said before,
market prices don’t move in straight lines - they ebb and flow, back and
forth in general directions over periods of time. Why draw a hard straight
line across a flowing chart? It doesn’t make sense to us. It’s like trying to
keep your dog in your yard with a short fence: he’s going to go where he
wants to go! And so will market prices.
We’d rather base our trend observations on moving averages. While they can be violated just like hard trend lines, the very fact that they move gives us more insight on future market direction than the violation of a hard trend line. And as we said, drawing hard trend lines can be very arbitrary. There’s no guess work where moving averages are drawn!
While we don’t care to use hard trend lines for making investment decisions, we do think it’s important to recognize them on our charts. Just like the support and resistance levels we spoke of earlier, watching the price action associated in an “encounter” with a hard trend line can give us some good insight to future market direction. Equally important, how other traders/investors react at these trend lines tells us a lot about the strength or weakness of a trend.