Stocks Technical Analysis Trendlines Part 2

Trendline Evolution

A medium to longer term uptrend or downtrend not always evolutes the same way. Looking at different charts and periods we noticed that from the start of a new price move, the trend shows three possible scenarios before reaching the end of that trend:

1. No change; the price continues to move along the trendline until it breaks the trendline.
2. The price accelerates and moves far away from the trendline; you need to draw a new, steeper trendline.
3. The price decelerates and breaks the trend moderately and continues, temporarily, less steep or even flat.
4. Of course in some longer term price moves you will find all three possibilities combined in one trend.
   
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No Change

If there’s no change (figure 4.21), the trendline stays intact during the whole up- or down-move.

When the trendline is broken, it is the start of a new trend in that specific time period.

It is rather uncommon that there is no change.

Medium- and long-term moves will show most of the time a change in trend acceleration.

Figure 4.21: No change in trendline evolution.

Accelerating

Price acceleration often is a three-step process (figure 4.22). The trend is broken after the third change in acceleration, when it has become a very sharp move.

Figure 4.22: Trendline acceleration.

Later when we talk about price chart patterns, you will see that these changes in acceleration often are announced by a price continuation pattern.

Slowing Down

A longer-term uptrend starting with a sharp up-move will generally slow down.

Figure 4.23: Trendline deceleration.

In figure 4.23, you can see how short-term reactions against the main trend will slow down the up-move. A longer-term flatter price channel is formed.

The S&P500 index in figure 4.23 gives a buy signal at the end of October 2004 when the closing price moves above the downtrend line. The price takes off with high acceleration. It is clear that this cannot be sustained for a long period of time.

The price continues to move higher, but not at the beginning speed. So when this sharp trendline is broken, do we have to close the position?

Because of the previously high acceleration, you should leave enough room for the price to slow down. For example, you can use a support line or a trailing stop level to allow this process.

Most of the time, the trailing stop will not be broken if the price continues to move higher.

After some time you can draw a flatter trendline followed by a steeper trendline, as is the case here.  You can of course, also adapt the slope from the start (dotted trendlines) to represent the new longer-term trendline.

Technical Analysis Trendlines Next -Previous -Part 1 -Part 2 -Part 3 -Part 4 -Part 5

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