public0

Trendlines & Channels Tutorial: Part 1

CMT Association's Market Insights features timely technical analysis of current global markets by veteran CMT charterholders. Each post appears on www.tradingview.com/u/CMT_Association/ in an effort to explain process, tools, and the responsible practice of technical analysis. Shared content and posted charts are intended to be used for informational and educational purposes only. The CMT Association does not offer, and this information shall not be understood or construed as, financial advice or investment recommendations. The information provided is not a substitute for advice from an investment professional. The CMT Association does not accept liability for any financial loss or damage our audience may incur.

Trendlines & Channels Tutorial: Part 1

S&P 500 SP:SPX

CMT_Association

This will be a multi part series on trendlines and channels, what they represent, how to draw and use them, and how I design trades around them.

For the sake of simplicity this series will focus on uptrends. Importantly, the principles are roughly the same for both uptrends and downtrends except that downtrends often develop more quickly.

I see many TL tutorials, but I don’t see much attention paid to what a TL or a channel top represents. Whether a long-term pattern or a shorter-term pattern like a key reversal or a gap, being thoughtful and understanding the supply/demand dynamic that forms each pattern will make you a better analyst/trader.

Trendlines represent the willingness of the composite investor to follow price higher/lower. In other words, uptrends represent the stride of demand and downtrends represent the stride of supply. As long as the composite investor is willing to buy/sell at consistently higher/lower levels, demand/supply remains consistent and the existing uptrend/downtrend is intact.

Channel tops are known as supply lines and represent areas where supply, generally profit taking, should be expected to develop.

The relationship between price and the TL and the channel top can offer important insight into the strength or weakness of the underlying trend. Failures to push to either the trendline or the channel top potentially warn of a change in the underlying trend. We will cover this in part 2.

What trendlines don’t offer, at least in my approach, are standalone trading opportunities. Automatically buying trendline touches or selling trendline breaks must be combined with tactical entry techniques in order to build a safe trade. Most specifically, TLs don’t offer reliable sell signals when they are broken. Tests, both of TLs and channels are simply “get ready” warnings.

A break of an uptrend does not change the underlying trend from up to down but to neutral. More work is typically needed to turn the trend.

A TL is two or more points connecting support or resistance pivots of roughly the same magnitude. A trend channel is formed by building a parallel trendline connecting an intervening pivot on the opposite side of the pattern. The channel top in an uptrend is the overbought or supply line.

It bears repeating, proper trendlines are drawn between intervening lows of roughly equal magnitudes and should never be forced. A TL is not tradable or informative if it does not conform to the natural path of the market. “Trendlines should be pretty.”

Trendlines evolve. Initial projected trendlines are consistently inconsistent. More often than not they will have to be adjusted as price action evolves.

In my estimation there are three primary types of trendlines:

Type (1) These trendlines are shallow and take a significant number of bars to resolve themselves. They are more useful for defining the trend than for trading.

Type (2) These trendlines are typically very steep and run along intraday or daily price lows or highs. These trendlines are very useful as entry triggers and become important as existing type 1 trendlines and channels are tested.

Type (3) These trendlines define the bottom/top portion of a tradable pattern or formation including rectangles. A pattern TL is more apt to provide tradable support or resistance, particularly if the market is overbought or oversold during a testing phase. The horizontal lines along the top of lateral congestion fall into this classification.

In part 2 I will cover how to utilize these sloped TLs and Channels to help understand the ebb and flow of supply and demand.

And finally, many of the topics and techniques discussed in this post are part of the CMT Associations Chartered Market Technician’s curriculum.

Good Trading:
Stewart Taylor, CMT
Chartered Market Technician
Taylor Financial Communications

Shared content and posted charts are intended to be used for informational and educational purposes only. The CMT Association does not offer, and this information shall not be understood or construed as, financial advice or investment recommendations. The information provided is not a substitute for advice from an investment professional. The CMT Association does not accept liability for any financial loss or damage our audience may incur.