How to Book Gains Using Trendlines
Trendlines can be confusing for newer traders.
But if you follow these simple tips, you quickly learn how to pull double-digit gains out of any market.
There’s a simple way to tell if you’re drawing your trendlines correctly.
The more price points that bounce off your trendline, the stronger your support or resistance level will be. As long as your lines are touching as many reversal points as possible, you should feel pretty confident about them.
Drawing your trendlines is not an exact science. Subjectivity is a big part of the guidelines. When you’re performing fundamental analysis, for example, there’s no hard and fast rule that a price-earnings ratio of 16 is good or bad. It depends on a wide range of factors. That means weighing variables like the industry you’re looking at, or the behavior of the overall market.
By that same token, the lines you draw on a chart are likely to be somewhat different from the lines drawn by another trader. Each market participant will have a slightly different viewpoint.
Part of that subjectivity comes from the fact that human behavior drives markets — in a very short time frame, the supply and demand balance can get thrown out of equilibrium by things like a massive order hitting the market, or short-term pockets of optimism or pessimism. When that happens, prices can “miss” a support or resistance level by a small margin before correcting.
At first, when you’re plotting these lines on a chart, you might think that the information is almost too simple to be of value. But it’s important to remember that you’re really doing a whole lot more than just drawing a line. Think of it this way: A fundamental analyst wouldn’t consider reading through financial statements equal to “looking through a booklet.” The analysis interpretations are the most-important aspects of any technique —whether technical or fundamental.
More compelling proof might be the fact that some traders are making tons of money following these strategies and drawing these simple lines on the charts. These levels work because markets are based on human behavior. At the end of the day, the buying and selling pressures that they represent are the only factors that directly impact a stock’s price.
With that, let’s move on to a couple of other trendline tips…
Remember, nothing in the market is static.
The trendlines you draw today — no matter how many points they connect — are not going to hold forever. Opinions, corporate fundamentals and economic factors all change. When they do, the trendlines that mark supply and demand eventually break.
Look at how a broken trendline in GMCR gave an early warning to investors:
When those lines are breached, they send us an important message. They tell us that the area where we previously found a constrained price movement no longer exists. Price action has moved outside of that zone. When the uptrend broke its support line in the above chart, it was a signal that the supply-demand equation was shifting toward sellers. Demand was no longer found along that trendline. Traders who took the cue locked in their gains and were spared from a massive sell-off.
It’s a big deal when a support or resistance level gets broken.
Taking a look at the above chart, you can see that the $10 resistance level was taken out. That’s called a breakout. When breakouts happen, there’s an increased probability of the move increasing, because significant demand was required to push shares above that resistance level that sellers were dominating. Buyers are now in control.
If you were to buy this stock on the break of $10, you could have booked significant gains in a matter of days. That’s why scouring the market for trendline breaks like this one is a sure-fire way to consistently grow your trading account.
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