Using Trendline and Trend Channel

Using Trendline and Trend Channel

http://newsletter.neoticker.com/2006/10/12/using-trendline-and-trend-channel/

by Lawrence Chan on Oct. 12th, 2006 in Basic Chart Reading | Trading - General

Many beginner traders have seen trendlines, but not many of them know how to draw trendlines properly. On the other hand, there are even less number of traders know what trend channel is.

I am no expert in trendline or trend channel usages – most of my knowledge about these tools came from my mentors and real life experience. I am going to talk about some basic concepts in using trendlines and trend channels that can help beginners to better understand these two useful technical tools.

Drawing Trendlines

Usual approach to trendline drawing is peak to peak. That means, you draw your trendlines from one swing high to another if you think you are dealing with a down trend. If you think you are working with an up trend, you can draw your trendlines from one swing low to the next.

Here is a trendline drawn from one peak to another,

Using Trendlines

Simply put, trendlines are used for identifying support and resistance price levels that change over time.

(For more information about Support and Resistance, take a look at the article Understanding the Pivot Points)

If you think that you are trading within a down trend, you use trendlines drawn from swing high to swing high for the identification of resistance price levels. Similarly, if you think you are trading within an up trend, you use trendlines drawn from swing low to swing low for the identification of support price levels.

The most important concept here is that you are speculating the direction of the trend. If your assumption of the trend is not correct, so will the projection you made based on the trendlines. Thats why it is very important to draw trendlines using both swing highs and swing lows so that you can have a more objective picture of what is unfolding in the price series.

Here is a chart showing a down trendline (the one in yellow) that acts as a resistance line and an up trendline (the one in green) that acts as a support line,

All Trendlines are Trend Channels

Whenever you draw a trendline the way I described above, there will always be price point that is furthest away from the trendline, measured from the closest point on the trendline. That is the point you can use to anchor the third control point of the trend channel drawing tool.

I extended the trendline (the one in green) from the previous chart into a trend channel,

Notice that a valid trend channel usually can be validated by its 50% line, where it is tested and bounced off. In our example chart, the test of 50% happened between point 2 and point 4.

Fibonacci Ratios in Trend Channels

From my experience, fibonacci ratio does not play an important role in trend channel based support resistance projections.

The reason why that is the case can simply be explained by the fact that not many traders use trend channel projections at all.

On the other hand, fibonacci ratio works much better when you are working with static price level projections that you can draw onto a chart using the fibonacci price projection drawing tool.

For Those Looking for Mathematical Explanation

Many traders who prefer mechanical trading systems over discretionary methods may find trendlines offensive to their beliefs.

By thinking of trendlines as measurement of price extremes, then it is obvious that trendlines are simply a quick way to get an approximation of such statistics and its projections.

By the same token, trend channels are quick measurement for projecting deviations from the original data range.

Next time, if you want to get a rough idea of the statistics, then pull out the trend channel tool to get the quick approximations.

Step-by-Step Walk-thru on a Daily Emini Nasdaq Chart

Here is an example showing how we draw trendlines.

1. Drawing the obvious one

2. Do not forget about the ones from opposite direction

3. Extend trendlines into trend channels if that interest you

4. Trend channels are good projection tool for price targets

5. Existing trend channels are valid until they are completely violated

6. When there is a need of expanding a trend channel, add the necessary multiple to the tool on demand. In this case, I have added -50% to the trend channel.

7. Combining with other technical indicators, you can use trend channel price levels as entries on overbought or oversold conditions

8. Same trend channel can be used over a long period of time

9. Original mid-channel price level is usually a very good support/resistance level

10. When new price extremes develop, you have to add new trendlines to get a better picture of the chart

11. Again, trendlines can be extended into trend channels when the need arise

12. Combining multiple trend channels can give very accurate projections – in both time and price

Similar Analysis Techniques

There are other analysis techniques that exploit momentum persistencies. For example, Andrew Pitchfork provides a much more mechanical way in defining its forks compare to the trend channel method mentioned here.

When you are using a particular drawing tool, just remember that you should always practice drawing the tool on the charts to make yourself comfortable. You should also learn to compare the projections against the actual outcomes based on the drawings you made on the chart.

Practice may not make perfect, but will get you closer.