If you are in the equity market and want to create wealth for yourself in the stock market, then you must be aware of how important it is to choose the right stock. And to choose the right stock, you must know how to analyze the company issuing the stock.
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What are the Trendlines?
Trendlines are just simple lines that are formed by connecting various points on the charts by the trader for analyzing the stock. Charts are not used alone but are used together with trendlines to enhance the effectiveness and accuracy of the trade by the traders. The trendline is used to indicate the direction of the stock’s price movement.
The trendline is important for both trade identification and confirmation in the technical analysis of the stock. Trendline will have two indications, first in an upward direction which is known as an uptrend. That means the movement of the value of a stock is following an uptrend i.e. price will further go high. Second, it is in a downward direction which is known as a downtrend which means the price will further go down or low.
A trendline is a straight line that connects two or more price points on the chart and extends further to make a base for support and resistance in the stock price’s movement. Trendlines indicate the direction of movement of a stock over a period of time.
Types of trendlines
Since the market normally follows two major trends which are uptrend and downtrend hence trendlines are also of two types namely the uptrend line and the downtrend line. The market follows one other trend namely a sideways trend as well, but that is not so much popular among traders because it does not give a chance of trade.
Uptrend line
Uptrend by name you can assume that it will be having a positive or upward slope and it is formed by connecting two or more lowest points of any chart. But to have a valid and informative trendline, you must connect a minimum of three points while forming a trendline. To form an uptrend, the second low point must be higher than the first low point on the chart.
The uptrend line acts as a support line for the stock price and it will indicate to the trader that the net demand of the stock is rising whatever may be the price of the stock at current. Net demand of stock means total demand subtracted from the supply. If you see that the price of the stock is rising with increasing demand, it is strongly bullish and throws a good opportunity for buyers.
An uptrend is considered intact until the price of the stock remains above this line. If the price breaks this level or line, it will indicate that net demand has weakened and a change in trend pattern can be there in near future.
Downtrend line
Downtrend by name you can assume that it will have a negative or downward slope and it is formed by connecting two or more highest points of any chart. But to have a valid and informative trendline, you must connect a minimum of three points while forming a trendline. To form a downtrend, the second high point must be lower than the first high point on the chart.
The downtrend line acts as a resistance line for the stock price and it will indicate to the trader that the net supply of the stock is rising whatever may be the price of the stock at current. Net supply of stock means total supply subtracted from the demand. If you see that the price of the stock is falling with increasing supply, it is strongly bearish and throws a good opportunity for sellers.
A downtrend is considered intact till the time the price of the stock remains below this line. If the price breaks this level or line, it will indicate that net supply has weakened and a change in trend pattern can be there in near future.
Spacing of points in trendline:
The points used to form the trendlines should be spaced equally with respect to each other i.e. points should not be too close or too far. The lower lows used to form an uptrend line and the higher highs used to form a downtrend line should not be too far apart, or too close together. The spacing among the points depends on the timeframe you choose, the degree of price movement, and personal preferences. If the lows (highs) are too close together, the validity of the reaction low (high) may be in question. If the lows are too far apart, the relationship between the two points could be suspect.
The steepness of the trendline
The trendline depiction should not be too steep on the chart i.e. the angle of the trendline must not be too big. Because, as the rise or slope of a trend line increases, the validity of the support or resistance level decreases. A steep trend line is a result of a quick fall or rise of price in a short period of time and the angle of the trend line created in such circumstances will not indicate meaningful support or resistance level.
Validity of the trendline
Generally, it takes two or more points to draw a trend line. The more points you use to draw the trend line, the more validity to the support or resistance level represented by the trend line you will find. Sometimes it’s difficult to find more than 2 points to construct a trend line so it is best not to force the issue. The general rule in technical analysis is that it takes two points to draw a trend line and the third point confirms the validity.
Bottom line
Trendlines are very much informative and helpful for a trader in planning their trades. The trendline offers a very important piece of information about the trade decisions a trader should make. But these trendlines must be used accurately and must always keep a margin of error of 10% with your trade.