Assessing the Validity of Trendlines

Oct 29, 2007: 6:43 PM CST

Trendline analysis is one of the oldest and most basic forms of ‘quick,’ top-level technical analysis possible. They are often easily ‘spotted’ yet frequently hold significance in terms of price inflecting off the trendline in a continuation of the current trend. What are some quick tips to assess the validity of observed trendlines?

While there may be other, deeper methods of analyzing how significant a trendline is, or how likely it will be to contain a price movement, there are three simple ‘tests’ one can run to assess the significance or validity of an approaching or drawn trendline:

1) Number of Times Touched

A trendline that has been ‘touched’ or ‘tested’ more times is often more significant, or more likely to ‘hold’ than one that has been tested a smaller amount of time. Recall that it often takes three points to draw a sufficient trendline, and the more times it has been touched, the more significant it is. This is likely because more people see the trendline, or there is some fundamental reason why a certain price (or level) holds as key support or resistance.

2) Angle of the Trendline

Trendlines can be horizontal, or sharply inclining or declining. As a rule, price movements that turn ‘parabolic’ frequently will fail at some near point in the future, and as such, trendlines with steeper angles of ascent or descent are less significant (more likely to be penetrated) than ones with angles less than 45 degrees. This is because trends with gradual price increases or decreases are more likely to be sustained than those with rapid price increases/decreases. The penetration of a steep trendline does not necessarily signal the end of a trend, but the return to a more reasonable or gradual price movement.

3) Length (timeframe) of Trendline

Trendlines that develop on a weekly chart are far more significant (likely to hold) than those that develop on a one-minute chart. Far more market participants are aware – and likely reactive – to the longer time-frame trendline because so few people will see and react to a one-minute trendline. The same is true for a trendline appearing on a five-minute chart or even an hourly chart. Trendlines of greater length, on higher time frames, are often more likely to ‘hold’ than those of shorter time-frame duration.

To construct a potential trendline, connect as many ‘price points’ as possible, and aim to connect a minimum of three price points. These could be swing lows (for an uptrend) or swing highs (for a downtrend), or other areas of observed support or resistance.

Technicians frequently prefer drawing more accurate trendlines through closing prices only. Closing prices hold more ‘conviction’ than intraday ‘spikes’ as observed on Candlestick charts. An intraday penetration of an observed trendline is less significant than a close beneath (or above) that trendline.

While trendline construction is one of the most basic and simplest forms of technical analysis, it can also be one of the most powerful forms of quick analysis of possible price behavior and market structure quantification.

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