Drawing Trend Lines
The trend is your friend, as the saying goes.
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A favorite motto among stock market traders is: The trend is your friend.
The point is you can't go wrong with your trades if you go with the flow -- if you stick to the trend of prices. If stocks are going up, you should be buying. If stocks are going down, you should be selling. Oh, sure, you can sign up with the wrong crowd and get stung a bit, but generally you won't go wrong by following the trend, or so the motto goes.
To go with the flow, you have to know which way the flow is flowing.
This trading policy may seem like playing follow the leader, and I suppose it is. But what's the alternative? You either let the market dictate, or try to dictate to the market. Unless you're worth a few trillion dollars, the only meaningful answer is to let the market inform you.
If you think you can control market prices, more power to you. I'm not against innovation. Try to lead! Be my guest! Indeed, you may have to be a leader to buy or sell on the value principle -- where you trade on the exchange value of the stock. Even here, though, to realize a profit you still have to wait for other buyers to recognize the value and bid the price higher. Prices don't change under their own steam.
Perhaps, though, you'd like to anticipate where the "train" is going and try to "board" before it starts, or at least before it picks up speed. To forecast its behavior, you need an encyclopedia of market psychology.
Either way, it ain't easy!
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One way to try to figure market direction is to draw trend lines. This is a simple forecasting device and shows market direction merely by its slope. Looking at price-time charts, if the angle is up and to the right, the trend is up. Contrariwise, if the angle is down and to the right, the trend is down. You buy in the former case, sell in the latter case.
Lower Highs & Higher Lows
How do you line up with the trend?
The answer, in short, is to find local price highs and local price lows and mark them as possible points of connection. Next you associate comparable lows with each other and comparable highs with each other. Then you associate successively higher lows with each other and draw connecting lines between them, and you associate successively lower highs with each other and draw connecting lines between them. But none of this means much until you establish your own reference.
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To find a useful trend for yourself, you need to set a reference. This is a personal matter -- it depends on your personal inclinations. If you do your own trading, you have to signify the time scale of your trend lines. Just as in computing the moving average, you must know the time period over which you intend to trade. You need a. reference.
It's important to see that a trend can be influenced by a higher-level trend. A longer trend has greater staying power -- that's why the trend is longer! So if you're not aware of a longer trend in your equity, you might miss the fact that the longer trend is reaching its limit and may turn before your lower trend trade has reached fruition. The longer-term trend can turn and cause the shorter-term trend to abort. To learn of the higher-level trends, you have to have charts that reflect the trends.
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The purpose of drawing trend lines is to project prices into the future, to get tomorrow's information today. To gain the right perspective, therefore, you have to be careful with your selection of trend-defining price points. Picking out the wrong points can result in bad trades.
The points to be used are key pivot, price exhaustion, or price-reversal levels, to use the words of Thomas DeMark, in his book New Marking Timing Techniques.
According to DeMark, you employ the two most recent declining tops to get an extended price resistance line, and you make use of the two most recent rising bottoms to define an extended price support line. In either case the extension is to the right on your chart, meaning into the future. In the first case the line represents a future source of supply of shares and thus a resistance line, and in the second the line is a future source of demand and thus a support line.
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