Using Trend Lines and RSI Together

01/07/2010 12:01 am EST

Focus: STRATEGIES

Alan Hall Andrews is most famous for having created the Andrews pitchfork, but he also developed many other trading techniques that worked so well that he included them in his trading notebook. One such technique was his unique way of using trend lines.

Like Ralph Nelson Elliott, who discovered that after five waves in one direction, the market was due to correct, Alan Andrews also used the number five in many of his trading techniques. Andrews used the number five when drawing his trend lines. He noted that five trend lines normally developed for a market under study in the main direction of the price movement. He observed that when the fifth trend line was broken, a high probability existed that the trend in motion had ended.

One of the problems with using trend lines is in drawing them. For years, traders recognized that there was no exact way to draw a trend line, as one trader would draw the trend line one way and another trader would draw it another way using the same price chart and the same time frame. Andrews developed a consistent way of drawing trend lines that removed these differences.

To draw his trend lines, Alan Andrews would draw a line from the lowest low, up and to the highest minor low point preceding the highest high without passing through any price points in between. For a downtrend, he would draw a line from the highest high point to the lowest minor high point without passing through any price points in between.

Figure 1 shows how Andrews would have drawn his trend lines on the daily price chart for the Market Vectors Gold Miners ETF (GDX). This chart shows four upward-sloping trend lines. According to Andrews' notes, five trend lines normally develop before a trend is ended. Therefore, according to Andrews' observations, GDX should make one more upward rally with at least one higher minor low, so a steeper trend line can be drawn before the upward trend for GDX ends. However, knowing that no trading technique is perfect, a breakdown below trend line four would put an early termination on the upward trend for GDX.

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FIGURE 1: GDX, DAILY. This chart shows the unique way that Alan Andrews used trend lines to determine when a trend should end. This chart also shows the relative strength index (RSI) below the bar chart.

To support Andrews' trend line technique, I have added the relative strength index (RSI) below the price chart. Note that during the complete upward trend that started in October 2008, RSI has remained above its 40% level. As a result, this market sees this level as important. RSI currently looks to be respecting the 40% level, signaling a high probability that GDX will move higher before the upward trend is complete. However, there are no guarantees in trading. So a breakdown of RSI to below 40% would warn that GDX could be ready to move lower and a move by RSI to below 30% would provide some confirmation.

In conclusion, GDX is still in a major upward trend and is expected to make at least one more upward rally before the trend comes to an end. However, a break down below trend line four and or a breakdown of RSI below its 40% level would warn that the upward trend for GDX is ready to end.

By Alan Northam of Traders Classroom

Alan Northam lives in the Dallas, Texas area and is a practicing electronic engineer, which gives him an analytical mind from which he has developed a thorough knowledge of stock market technical analysis. His abilities to analyze the future direction of the stock market have allowed him to successfully trade of his own portfolio over the last 30 years. You can reach him at info@tradersclassroom.com or by visiting his Web site, www.tradersclassroom.com.

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