I believe technical analysis is important for any trader out there and not understanding the basics could be detrimental to their success. Trend Lines are one of the most important tools used in technical analysis. It is also one of the simplest form of technical
analysis and is used for both trend identification and trend confirmation. By definition, a trend line is a straight line that connects two or more points on a stock chart. As trend line is drawn, it would be extended into the future to act as a line of support/resistance.
analysis and is used for both trend identification and trend confirmation. By definition, a trend line is a straight line that connects two or more points on a stock chart. As trend line is drawn, it would be extended into the future to act as a line of support/resistance.
Obviously, there are two types of trend lines: an uptrend line and a downtrend line. An uptrend line acts as support by connecting two or more major lows. The second low must be higher than the first one to get an uptrend line. As long as prices remain above the trend line, the uptrend is considered strong. An uptrend line is used to determine whether the trend will continue into future or will be broken.
Below is a 3 month chart for AAPL created prior to the open on 10/19/10. I have drawn an uptrend line using the two points and have extended out into future by several days. I have also placed a red circle signifying potential retracement back to this uptrend line. In this example, it was easier for me to predict the retracement back to $300 level because I know in the premarket that AAPL has declined a lot. You can predict two possible direction for AAPL using this information. AAPL can either touch this uptrend line this week and possibly take off just like 11 days ago or it can break this uptrend line and continue to fall below $300.
I currently do not own AAPL shares but if I had shares, then I would use this information and place a STOP Limit order at $295 (see purple line).
Important note on Trend line: Now you know it takes two or more points to draw a trend line. However, do you know that the more points used to draw the trend line, the more valid the trend line becomes? Also, the longer the trend line in terms of time frame, the more significant a break can become. So here is the general rule in technical analysis: it takes two points to draw a trend line and the third point confirms the validity.
So, going back to our example above with AAPL, there is no strong validity to the upward trend because the third point does not exists yet and this trend is only 2 months long. Even if AAPL breaks the uptrend line, the price most likely will not fall too much below $300. This means there is potential for the STOP Limit order to execute and the price would immediately jump higher. All these information is important to consider in your strategy for trading AAPL.
My prediction for AAPL would be that it will retrace back to around $300 level and start going up again. By making this retracement, AAPL would have made the third point for validity and would extend the upward trend into 3rd month.
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