TA: Introduction to Trend Lines

You’ve probably heard about Technical Analysis from my previous articles and may be wondering to yourself, “How should I begin?” I feel that a great start would be learn about Trend Lines because it is the first step to knowing what Support and Resistance mean. You may wonder why is it important, and I hope that by the time you reach the end of the article, you would see it’s effectiveness and be convinced yourself. Perhaps, even try it out for yourself! I have been using trend lines faithfully and they have always served me well in my investments.

What are Trend Lines?

Trend lines are basically lines that you draw on charts that shows you the general direction of a trend. It is useful to help find potential support and resistance levels so you can time your entry and exit better. And the best part of it all, it’s not hard at all and can be performed on any charts! All you need to do is to find the best fit support or resistance line via trial and error by connecting the bottoms or tops of a trend. Here’s an example:

CWT Chart

 

Here I have presented you with a chart that shows you two support lines (S1 and S2) and one resistance line (R1). It definitely doesn’t look too hard to draw isn’t it? Simply connect the bottoms of a trend and there you have it, a beautiful trend line that can help you spot the next bottom to enter your trade! You’ve always heard of people trying to “time the market”, this is one of the ways traders time their trade. Take for example the trade towards the right of the chart, at S2. Look at how easy it would have been for traders to time their entry and exit just by drawing two lines! Buy when it touches S2, and sell when it touches R1.

Trend Lines Keep Changing!

Had you not drawn the trend lines, would you have known at what price you should enter and at what price you should have exited at? Drawing trend lines help to clearly show where the next potential support and resistance will be at. I place emphasis on the word “potential” because it is not a guarantee that the trend will stay the same forever. Look at S1, it stayed in effect for about 6 months before the trend line is broken, and then we ignore S1 and move on to S2. Same goes for R1 where it was effective for 7 months before it was penetrated in mid-March. This penetrating move then renders R1 meaningless now while S2 is still in play because it hasn’t been breached.

It’s All About Practicing

I understand it can get a little confusing, but when it comes to trend lines, it is all about practice! Keep drawing and fine-tuning your accuracy when drawing these trend line because you will be rewarded at the end of the day! You can practice charting using the software I’m using, Chartnexus. (Note: I’m not receiving any commission for introducing this software from Chartnexus, it’s just that it has helped me a lot and I wanted to share with readers who are interested in Technical Analysis and it would help when I teach more about TA in the future.) Some of you may already have access to charts, do give it a try! Some charts are harder to have their trend line drawn and some are easier. Keep trying and eventually move to harder charts to improve your accuracy!

 

Disclaimer: The above chart is for learning purposes only and not a recommendation to buy or sell. Always conduct due diligence when making a purchase or sale of a stock.

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Technical Analysis – The answer to “When to buy?”

Why Should I Consider Technical Analysis?

For questions like “What to buy?” requires fundamental analysis. But when someone asks, “When to buy?” This is when technical analysis comes into play. Technical analysis is the other approach of investing. When you talk about technical analysis, you’re looking at things like charts, chart patterns, technical indicators, etc. It gives you a visual information about how the stock price moves for the minute, the hour, the day, week and even month! This information is useful because it can give you a better sense of how the stock is doing right at the moment. Fundamental analysts usually have to deal with information that isn’t updated because company reports would only come out quarterly, or even annually! Many things happen in between the quarters but you could possibly be trading based on the previous quarter’s results which may no longer be relevant.

Pure technical analysts are not interested in the research of a company’s fundamentals because the way a stock price moves would have indicated how much everyone thinks the stock is generally worth. When an undervalued stock moves because it was uncovered by a fundamental analyst, it wouldn’t be missed by technical analyst who watch price-volume action of a share price. As long as a stock moves, the technical analysts will be there watching it as well! Price movements can give a technical analyst a lot of information such as breakouts, psychology of the market players, trend, reversal patterns, etc. These days, there are a lot of people relying on charts when buying a stock. You would only be putting yourself in a disadvantaged position if you choose not to avail yourself to the same information they are receiving. With more and more speculators in the market, fundamentals might be ignored for short moments and only technical analysis can help you for the moment to be profitable.

Here’s an example:

chart (14)

A pure fundamental analyst would not know where the support or the resistance is. He would know what the company should be valued at but he may not know when is the best time to enter. For example, NOL is down-trending from $2.30. A fundamental analyst values it at $1.50 based on Price-Book ratio, P/E ratio, or other metrics available to him. When NOL sells down to $1.50, the fundamental analyst would make the purchase because he thinks that is what it is worth. However, from a technical analyst point of view, he would wait to see if $1.50 is supported or not. If the price is not supported, he waits for the share price to continue falling and test the next support level at $1. When share price eventually gets to $1 and shows that it is supported with a high volume, the technical analyst buys it.

At the end of the day, both analysts got NOL, but the technical analyst got a better price because he knows that from past price movements that $1 is a strong psychological support and buys it at a support instead of simply buying it because he thinks that is what it is worth. Past price actions can give you a hint about the future price movement because of many reasons, largely psychological support and resistance levels. The fact is that many people are relying on such information, and if you aren’t, you will lose out and the market will not make sense to you. Having a visual image of how the stock market is going will be very much easier for you to find support levels such as in the case above.

 

Of course, this is not to say that technical analysis is 100% accurate and gives you pin-point accuracy. What it can provide you is more information that opens up your eyes to more opportunities for buying entries. There is always a time an investor will face where he says “I’m waiting for the right time to enter”. It could be a fundamentally sound company but simply trading too expensively and this is when technical analysis will tell you when the right time is. Or rather, give you a hint of when the right time is. Of course, hindsight is 20/20 and the chart above could have gone in a totally different direction and crashed through $1 rather than stay supported on 2 more counts on Nov 2011 and May 2012. I used an old chart for the purpose of effectively sending my point across rather than try to teach based on current prices where even I don’t know where the future is. No one can predict how the future price will move, they can only get a vague idea of it. By effectively utilising both fundamental and technical analysis, you would put yourself in a profitable position where the odds of a profitable trade is higher.

Important Disclaimer

The above chart is for teaching purposes only and is not a recommendation to buy/sell.

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