Notice the line drawn on the chart below? This is called a trend line. The bottom trend line is also known as a trend support line. The top trend line is known as a trend resistance line.
There are a couple of rules to follow when drawing trend lines on a stock chart. You can find trends for a short period of time, such as five days, or a longer period such as one year. It is best when drawing trend lines on a stock chart to first look at the big picture and start with longer time period such as one year, then draw trend lines on a shorter time frame such as the five day chart. This will give you a better understanding of the overall trend both long term and short term of the stock you are studying.
Rules for trend lines:
The first rule for trend lines Is that the candlestick bars must touch your trend line in at least three places for it to be a valid trend. So as you can see in the example above our candlesticks come down and the chart trend line in multiple places. Can you see a place to draw in the top trend line? If you have to get out your ruler and place it on your computer monitor and it will be much easier to see where the top trend line exists.
Once you have your top and bottom trend lines established, you want to take a look at the pattern and direction of the trend lines formed. Is it a channel? Do they form a pennant or flag shape? Is the trend going up or down?
The pattern and direction of your trend lines can help you to decide to enter or exit the stock, and what to expect possibly for future moves. So using our example If the candlestick price were to start to close below the bottom trend line, we could assume that support has been broken and the stock price will continue to fall. Conversely, if the candlesticks were to close above the top trendline, we would look for the price action to continue and for the stock to make gains. Please note however on breakouts of resistance trend lines we do want to see confirmation before making an entry. Confirmation can be defined as a retest of the resistance level. In other words, the stock price breaks out above that resistance trend line and then the stock price comes back down to test that trend line and bounces off of it. Such as the price action around the 24th. This could possibly confirm the stock price movement to the upside. Once a stock price has broken above a resistance trend line and tested it for confirmation that trend line can now be considered to be a support trend line and a new trend would be formed. If the stock price were to then fall back below that support trend line, that would be considered a sell signal and we would watch for it to test the previous bottom trend line. Look for confirmation of support, triggering a new buy signal.
Trend lines can be very helpful when reading stock charts, but should not be relied upon solely for making buy and sell decisions. Ideally you want to use trendlines in conjunction with other stock indicators such as MACD and moving averages to make a better guess.
When reading a stock chart using trend lines It is a good idea to keep this motto In mind:
The trend is your friend.
What this means is; if trend lines are going up, you should be bullish, and if trend lines are going down You should be bearish.
A good way to practice drawing your trend lines is to print out some stock charts and using your ruler and pencil draw in the trend lines that you find. You can draw in horizontal support and resistance lines also, using the three touch rule. The horizontal support and resistance lines can give you a good idea of buy and sell triggers also, and you can find some nice break out opportunities to buy or breakdowns to short.
Please bear in mind that these trendlines are for information purposes only And should not be relied upon solely to make your stock buying decisions.