Trendline


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A trendline is a straight line drawn at successive high or low points on a price chart which can then be used for future support and resistance. While a trendline is typically drawn on a price chart manually, some software packages can create an automatic trendline.

When a stock price is trending upwards, that movement is often mixed with smaller degrees of up and down volatility. For example, if a stock price rises 10%, that upward movement may include 5 or more up and down swings of 2%.

trendlineAutomatic Trendline in StrataSearch Showing Support

By drawing a trendline from the lowest price of the first downward swing to the lowest price of the second downward swing, a trendline can be drawn that quite accurately predicts the lowest price of one or more additional downward swings. The trendline can then be used as a support level, identifying how low the price will go before a reversal again sends the price higher.

Likewise, a trendline can be used for resistance at the high prices. By drawing a trendline from the highest price of the first upward swing to the highest price of the second upward swing, the trendline can successfully predict the highest price of one or more additional upward swings.

A trendline is broken when the price breaks through the support or resistance line drawn from the prior highs or lows. While the price may return to the pattern, keeping the support or resistance trendline ultimately intact, the higher-level trend often needs to be re-evaluated and the trendline redrawn with the new highs and lows.

There are several drawbacks to using a trendline to buy and sell stocks or other securities. The first is that a trendline can be drawn quite accurately using historical data, but can be more challenging when using current data. When attempting to draw the current trendline, the slope and direction of the trendline can change with each new price that arrives. It is only on the third swing that the trendline becomes available for trading, and in some cases the trend may be losing strength at that point.

Another drawback to using a trendline for buy and sell signals is that the system typically cannot be back-tested. When the trendline is drawn manually, and the line can change each day based on the data currently available, back-testing to see how the system would have performed historically is typically not an option.

To use a trendline, a trader often uses a software package with drawing tools that allow the trader to manually draw the trendline on a price chart. Some software packages can display an automatic trendline, meaning the trader doesn't need to draw the trendline manually. One software package, StrataSearch, takes this a step further by identifying the slope and direction of the current trendline for each day in a historical price series. With the historical data available, StrataSearch users have the unique ability to back-test their trendline systems.

trendline
Automatic Trendline in StrataSearch Showing Resistance

While there are many technical analysis formulas that traders can use to identify profitable buy and sell signals, a trendline is often considered one of the more useful. The use of a trendline often takes experience when used manually, and can be slow when used for a large number of price charts on an intraday basis. But the use of an automatic trendline can greatly help the individual trader in identifying successful support and resistance levels.