It is through the use of trend lines and Dow Theory where we will learn our first analytical method. Trend lines are one of the most important tools in technical analysis and should never be overlooked. The use of trend lines can be found in almost every technical method. In our first application of trend lines, we will apply them to the price chart.
The first consideration when looking at any market is the direction of the long term trend (with the exception of day traders).
Prices can only go in three directions; up, down, and sideways. A long line of past price ranges together gives you a pattern. There will be plenty of dips and bumps along the line but you should still be able to discern a general direction up, down, or sideways. We can help spot this direction or trend by drawing in "trendlines".
Drawing trendlines during an up trending market: The trendlines above have been drawn by connecting as many successive lows as possible (along the bottom of the price range). An up trending trendline represents major support for prices as long as it is not violated.
Trendlines connecting highs can also be drawn to indicate the top of the established trend or channel (blue lines). These trendlines indicate the major zones of resistance. (See below for a discussion of support& resistance).
Drawing trendlines in a down trending market. Down trending trendlines are drawn by connecting the successive highs.
Trends can push and pull the price up or down. Markets can also enter a period of quiet stability where the price forms a horizontal line sideways across the page. A sideways trending market is normally a difficult market to trade for a profit. It can, however, set the stage for a sharp move once the sideways trend is broken (signalled by a price break through a well-established trendline).
A sideways pattern represents stability between supply and demand in the marketplace. Trendlines in this type of market, often referred to as a narrow trading range or congestive phase, are drawn by connecting both the highs and lows. Prices In this type of market can break upward or downward so it is valuable to establish the top and bottom of the range (see the report on Breakout Signals.