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Part 4 - Trendlines

Monday 13 August 2012


Having understood the upward and downward movement of price of a scrip, it is time to understand the concept of trendlines. Trendlines are formed by connecting at least two tops or two bottoms. Thus, trendlines are straight lines that are formed by connecting the tops and bottoms as illustrated by way of a chart. The larger the number of tops and bottoms in a chart, the better will be the output as shown by the trendlines. Trendlines are one of the simplest and yet most effective ways of predicting the market behaviour and expectations of the future prices of a scrip or index. In the previous chapters, we have learnt that there are three types of trends. These are rising, falling and flat trends. Similarly, there are three variants of trendlines. These are rising trendlines, falling trendlines and flat trendlines.


The rising trendline will track an upward movement in the price of a scrip and is formed by connecting the upwardly moving bottoms in a chart. The falling trendline represents a downward movement in the scrip price and is formed by connecting the falling tops as depicted by way of a price chart. In case of prices moving in a narrow band or remaining flat, the trendline is formed by connecting the even tops as well as even bottoms of the price of a scrip. Each of these market behaviour scenarios may be depicted by way of the following figures:




Importance of Trendlines
Trendlines are a good indicator of directional changes in the price of scrips, if these lines are breached by technical charts. These breaches (which are also termed as a violation of the trendline), give clues about the possible buy or sale decisions an investor can take. Thus, whenever these trendlines intersect the actual price movement as depicted by way of a chart, a reversal of direction may be expected. Hence, it may require you to make an investment or exit an existing investment. This may be explained by way of following figures:





Violation of Trendlines
It is important to remember that all violations of trendlines do not necessarily mean reversal of trends. It is possible that in case of a rising trendline, if the trendline is violated, it will mean a temporary halt rather than an actual reversal of price movement. Similarly, in case of a falling trendline, it is possible that the violation may lead to a slower fall but the same direction of movement may continue rather than a reversal of movement. Whether a violation indicates a reversal or a temporary setback would depend upon a number of factor such as the volume position, the time period under consideration, the number of points touched, the steepness of the trendline, a reversal pattern formation and so on. It is good to carry out an analysis of the same for the purpose of gaining a positive indication of the potential price movements and direction thereof.

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