Trendlines are the basic tool of a chartist.
Use an open/high/low/close line and bar graph (open is optional) constructed over set time interval bars along the horizontal axis and equal price divisions in the vertical axis. The time frame can be anything, but commonly used time intervals are 5, 10, 15, 30 and 60 minutes, then daily, weekly and monthly.
If the price action is generally heading higher draw a straight line beneath the chart bar lows. Link at least the two lowest points and extend the line beyond the current date. The more points you can link, the better the trend. Three points are ideal to denote a trend, although preferably not consecutive bars.
One can assume the market will continue in the direction of the trend until the trend is broken. In the case of an uptrend, buying opportunities are presented when the price is above the trend line. One can use the fact that the trend line has just been tested and held as a signal to buy the market. Tested and held means the price has moved down to the trendline, touched it and then rallied, moved higher.
Conversely, it is true that a break of that same up-sloping trendline could be interpreted as a signal to sell - either to liquidate a long position or to instigate a short position.
A bear market is denoted by lower lows and lower highs occurring on a normal bar chart. In this case construct the down trendline by drawing a straight line across the tops of these bars - the slope of the line will be down. It is good to pick up as many points as you can. Not all points have to be exactly on the trendline. The term trend actually means 'the general course, the general direction'. Therefore, as in the example below, we can allow for minor digressions above the trendline before we determine the trendline has been broken.
As the price gets close to the down trendline it provides us with the best opportunity to sell the market, to get short. The further the price is from the trendline, the greater the risk attached to selling short.
"Up by the stairs and down via the elevator". Bear markets can often be extremely vicious and for futures traders can provide some of the biggest trading windfalls. It seems that spike lows are often more prevalent than spikes on the high side. This is typical of bear markets, but by the same token these spike lows often denote the end of a move, the end of a trend. According to trend line theory we should wait until the trendline is actually broken before we say that the down trend has finished.
A trend line is broken when, in the case of the downtrend, the price moves above the trend. Some traders require the close of the relevant price bar to be above the trend line, which will often save the trader from 'whiplash'. Whiplash means getting taken out of the market when a trend is 'broken' only to find the trend immediately resumes and had not really been broken.
© The MacLean Group Pty Ltd ACN 096 967 038. All rights reserved 2003. This article has been prepared by The MacLean Group and licensed to ASX. The views are those of the author and not of ASX. This material is educational and it is not intended to constitute financial advice.