Before we get into breakouts, it is crucial to learn about this tool called Trend Lines. It is one of the best tools when it comes to technical analysis. Basic, simple and effective. There are tonnes of other tools available like RSI, Stochastics and Moving Averages that seem to make your trading charts look more sophisticated, but end of the day, does not provide quick decision making as effective as just a simple trend line. You may explore further on the other tools but first, you’ve got to master this.
In uptrends, trend lines are typically drawn connecting as many higher lows as possible. A typical trend line connects a minimum of 3 higher lows. Below is an example of a good trend line that connects multiple higher lows.
Notice that in this example, a OHLC (Open High Low Close) bar chart is used instead of earlier line charts. There are some slight differences to be explained here. Typically, candle sticks or OHLC charts are used to provide higher accuracy. Line charts only provide close price and you may not be able to notice some fluctuations that occur in the day. With OHLC or candle sticks, you can clearly define the max and min price movements in the day.
Figure: Basic uptrend line
Let’s get one step further. This is a trick that has proven very useful if you are a swing trader who wants to buy at a safe spot and sell at the highs while the stock is climbing with solid strength.
One way to draw the upper trend line is to connect as many higher highs as you can or another method is to create a parallel line and pull it up to connect to the nearest higher highs. Typically I prefer to use the parallel line method as it has proven very indicative of future prices.
Figure: Uptrend Channel
From above figure, take for example you are looking at the chart in Jun and the chart is empty from Jun onwards. You’ll draw an uptrend trend line is drawn based on the first 3 higher lows as indicated with blue circles. Extend the line, and you’ll create an indicative future path. Next, draw the upper channel using the parallel line method.
Just to give you a flavor on one of the trading strategies, you can use the channel as a signal for entries and exits. When the price falls back to the lower trend line, it will be a good entry point for buy. And when it hits the high trend line, it will signal a good exit point for sell. You’ll never want to trade against the trend, hence it is not advisable to short at the red circles. Always trend along with the trend.
There is a slight break in the trend after the green circle. There are two scenarios to this. You’ll either be stopped out, meaning you’ll exit your trade because the trend is broken or you may choose to run with the trade because it the price has not broken the last low, which we call the resistance. We’ll go into support and resistance right shortly.
Downtrends lines and Channels
Fast tracking a little, downtrend trend lines and channels are pretty much the same except that you start drawing the downtrend line with the lower highs as indicated with the blue circles followed by a parallel line connecting the lower lows.
Sideways channel is basically created by drawing an upper horizontal line joining as many tops as you can and drawing a lower horizontal line joining as lows as you can.
FIgure: Sideways Channel
As you can see very clearly, this can quickly be converted into an easy trading strategy by buying at the lower trendline and selling at the upper trendline. Vice versa, you can short sell at the upper trend line and buy back at the lower trendline. Both ways are equality profitable.
Check out the next section on supports and resistances.