Even master technicians had simple beginnings, and these insights and real market examples are intended to help beginners develop the skills to analyze charts and spot opportunities in the markets.
The leading book on technical analysis at the time was Technical Analysis of Stock Trends, by Edwards and Magee. My learning curve consisted of reviewing literally thousands of charts in the early years, drawing multiple trend lines, and then observing what happened.
Chart analysis can be fairly subjective, and I have often been asked during seminars “Why did you use this trend line instead of another one?” Therefore, I thought that an explanation of how and why I draw trend lines might be helpful to beginning chartists, as well as provide the more experienced chart readers with some additional perspective.
First of all, it should be noted that in preparing charts for my regular articles, I often start out with a series of trend lines, but only include one or two in the published chart. I realized early on that it was often better if I did not know much, if anything, about the company when doing my analysis, because that kept me more objective. Therefore, in the first few examples, I will not reveal either the company name or the time period I am reviewing.
This daily chart allows me to share some examples of the key guidelines that I follow when analyzing a market. The first guideline is that time is important. The longer it takes to develop a trend line or area of support or resistance, the more important that level is to the market's trend.
The second guideline is that the greater the number of points that can be used to identify an important support or resistance level, the more likely it is that prices will respect that level. The uptrend, line b, is drawn using the February, March, and April lows. The low in May was $15.13, which was comfortably above the trend line at $14.96. The low in September held just a few cents above this support.
A common mistake I notice when working with some short-term traders is that they use a five-, 15-, and 60-minute chart, and though they may have a daily chart on their screen, it is not studied as rigorously as the other time periods. When this is pointed out, the answer is that they were just looking for set-ups on the 15- and 60-minute charts. The problem with that is sometimes an intraday set-up will come at an important level on the daily chart that limits its chance of success.
From the June and July highs, one was able to identify a level of resistance, line a, that was also tested in August and approached in early September. The stock then dropped sharply to test the uptrend, but held above the June lows, which was a reason to stay positive on the stock.
Though the breakout was accompanied by better-than-average volume, it was less than what was observed on the prior decline. Ideally, this is not what one wants to see. Nevertheless, prices held above the breakout level for the following two days, suggesting the uptrend had resumed.
The stock made a series of higher lows and higher highs over the next few months, but the short-term uptrend that might have been derived from those lows was violated on the drop in November. This was then a good focal point for a new uptrend (line c).
Prices held above this support (line d) until early February, as the daily chart developed a pattern of lower highs and lower lows. This made the short-term trend negative, but as long as the long-term support (line b) held, the intermediate trend remained positive.
NEXT: Spot Key Trends on the Weekly Chart