[ Trendlines ]
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One of the most important concepts in technical analysis is the trend, and we have all heard repeatedly that "the trend is your friend." But despite this, there are an overwhelming number of people, amateurs and even professionals alike, who do not know how to properly draw a trendline.
The following guidelines I am about to present are consistent with Victor Sperandeo's teachings on how to properly draw a trendline. For those of you who are not familiar with "Trader Vic," he is one of the most successful traders profiled in Jack Schwager's The New Market Wizards, with an enviable 10-year nominal annual rate of return of 70.71% in the period between 1978 to 1987 (he returned 165.4% in 1987), versus 11.5% for the S&P 500 during the same time period.
One of the biggest mistakes made by amateurs and professionals alike is inconsistently defining and drawing the trendline. The method Sperandeo has devised is very simple and very consistent. "It fits both the definition of a trend and the inferences drawn from Dow Theory pertaining to the elements of a change in trend"(Trader Vic: Methods of a Wall Street Master):
1. Select the time period under consideration: the long term (months to years), the intermediate term (weeks to months), or the short term (days to weeks).
1. For an uptrend: draw a line from the lowest low, to the highest low point that precedes the highest high. You must make sure that the line does not pass through the prices in between the two low points.
1. For a downtrend, it's just the opposite: draw a line from the highest high, to the lowest high point that precedes the lowest low. Also make sure that the line does not pass through the prices in between the two high points.
The terminology can be very tricky, so I recommended that you reread the above until it all makes sense. Now, to put theory to practice, let's apply what we've learned to a real-world chart:
Let's take the company many people love to hate: Microsoft (MSFT)
The time under consideration will be from February to October of 1997, and we will be drawing an uptrend.
The lowest low before the highest low that precedes the highest high of the period under consideration is $93.375, established on 4/14/97.
The highest low that precedes the highest high of the period under consideration is $123.25, established on 7/01/97.
The highest high of the period is $150.75, established on 7/17/97 (kind of nice that some Tom DeMark indicators called the top of the move-they're currently beyond me though).
The uptrend was broken on 8/12/97, and notice how afterwards the market moved into a period of consolidation. Time to jump onto a fresher horse, so to speak.
For the downtrend exercise, I will leave that to you for practice. I would suggest trying it on something easy, like our friend, Eastman Kodak (EK).
Regards,
Rainier |
